In my last post we discussed that, while education is definitely good, it is not wise to take out student loans unless there is a financial payoff for doing so. In other words, you need to increase your earning potential enough through your schooling that you can pay your student loans off in a reasonable amount of time and then start reaping the rewards of your increased earning power.
So how can you decide if student loans make sense for you? I propose using a simple Student Loan Payoff calculation. To calculate your student loan payoff in years do the following:
- Estimate your annual income after graduation – Be conservative in this estimate and use the average of what people with the degree you are working towards actually start off making, not what is possible if you hit the jackpot and get your dream job immediately upon graduation. I know you are not average (none of us believe we are) but use the average anyway. At the very least it will probably take some time for you to convince the job market that you are not average.
- Estimate your annual income with your current earning power – This is the amount you are currently making, or what you could make if you worked full time with your current level of skill and education.
- Calculate your increased annual earning power – Subtract your current earning power from your estimated earning power after graduation. Your education should be worth at least this much every year after graduation.
- Estimate how much you will owe in student loans when you graduate
- Calculate your student loan payoff in years – This is done by dividing your estimated level of student loan debt by your increased earning power.
Other factors can be included to make the estimate more accurate (future raises after graduation, interest owed on the loan, etc.) but I think the simple calculation outlined above will provide enough information to help you make an educated decision on whether or not student loans are wise in your situation.
Example of a Student Loan Payoff Calculation
As an example, let’s assume you currently make $30,000 per year and a conservative estimate of what you can make after graduation is $40,000 per year. Let’s further assume that you will have to take out $25,000 in student loans (just less than the national average) to get your degree.
Your increased earning power would be $10,000 per year ($40,000 less $30,000) and your payoff would be 2.5 years ($25,000/$10,000).
If, instead, you can only make $35,000 after graduation and you would have to take out $50,000 in student loans to get your degree, then your payoff would be 10 years ($50,000/$5,000).
What Does it Mean?
So how do you interpret your student loan payoff calculation? While there is no hard and fast rule I would be very comfortable taking out the loans if the payoff is under five years. On the other hand, if the payoff is over ten years I would come up with another plan.
If the payoff is between five and ten years you have a difficult decision to make, and might want to consider steps you can take to make the payoff more favorable. However you interpret the results you are better off doing the calculation before taking out the loans rather than going in blind.
What to do if the Numbers Don’t Add Up
So what if the numbers don’t add up? Does that mean there is no hope for you and you will be forever stuck in the same dead-end job? Absolutely not. Consider the following options:
- Consider a cheaper school
- Consider a degree with a higher payoff
- Work while going to school
- Look for additional scholarships and grants
- Consider online classes for fulfilling at least some of your requirements. Online courses are usually quite a bit cheaper than traditional college (sometimes free), are becoming more and more popular, and are offered by many great schools. Before you spend a lot of time and money on these courses make sure they fit into your educational goals, that completion earns you actual college credit, and that the credits you earn transfer to other schools you are considering.
- Save money for schooling in advance. Look into Individual Development Accounts and similar programs. These are savings programs that generously match what you save. If you qualify it is a fantastic way to help pay for schooling. The match for the IDA in my home state of Utah is 3/1, meaning the program will match every dollar you save with 3 additional dollars up to a maximum of $1,500, giving you a total of $6,000 to use for schooling.
Remember You Are a Struggling Student
Student loans are fairly easy to get and repayment doesn’t start until after you finish your schooling. These circumstances lead some students to see student loans as “easy money” and they end up borrowing more than is absolutely necessary.
I was listening to a personal finance talk show on the radio when a gentleman called in and confessed that he and his wife, both doctors, owed several hundred thousand dollars in student loans from medical school. The host said that he understood medical school was expensive but the amount they owed still seemed excessive. The man admitted that “We lived like doctors while we were in medical school, and now that we are doctors we have to live like students.”
Don’t fall in to this trap. Do whatever you can to limit the amount you have to borrow for your education. When you are a struggling student, live like you are a struggling student. Then when you graduate you will be able to pay off your student loans in a reasonable amount of time and enjoy the fruits of your increased earning power.
Student loans should really be your last option. There are many other ways to get your education paid for free believe it or not. Many people just don’t go out there looking. There are grants state and federal. Your state aid should be easy to get because they make the qualifications fairly low. You can do work study which is like a part time job that the school helps you find on campus for you to earn extra money. Also when you do get that letter from your school about the awards that they are giving you, look for a Stafford subsidized loan. Even though it’s a loan, you should definitely take it because it’s a loan that doesn’t require you to pay an interest on until six months after you graduate. The government pays for the interest until you graduate. So you should take that money even if you don’t need it and invest it in mutual funds or in a savings account and let it earn interest. That way when its time for you to pay it back, you will have all the money to give back plus you get to keep the interest it earned for you! Kind of like free money. But like I said, actual regular Settle Student Loans should be your last option!!
I’m glad I stumbled on this blog! I thought this was an excellent article, but I also think the subsidized federal loan should be mentioned. I was able to get my graduate education paid by teaching an undergrad class each semester, but despite this I also got a subsidized loan for the maximum amount possible. I invested it, and then when I finished school I had an extra $2,000 of easy money with hardly any effort required. I don’t think this approach is for everyone because it requires some self control, but I was glad I did it.
Glad you enjoyed the article. I have heard about this strategy before and I can’t argue with the financial validity of it. You are basically getting an interest free loan until you graduate, and if you invest the money instead of spending it you will probably come out ahead. However, I am wary about suggesting it on my blog because, as you stated, it probably takes more self-control than most people have. Anyway, I am glad it worked for you, and congratulations on graduating without any student loan debt. Well done.