Borrowing for College: Exercising financial responsibility
Borrowing Money for College
I graduated from business school in 1983 with what at the time seemed like an inordinate amount of debt. When I started the MBA program I had little savings to pay for my two years of additional education, having spent the time between college and graduate school as a struggling musician in New York City. However, with some cash from a six-month music gig in South America, but mostly on borrowing, I financed my business school years. I was also able to cover most of my living expenses, including the rent on my apartment in the posh Lincoln Center neighborhood. By the time I graduated, I had amassed a staggering $20,000 in mostly government subsidized student loans. Understand that in 1983 this was a huge amount of debt to pay down, and I dreaded the thought of having to make that monthly $253 payment.
When I compare this to my starting salary fresh out of graduate school, and with no other outstanding debts, I now realize that this was not so bad, especially when viewed in light of the borrowing that students undertake today. My loan payments, even at a steep 9% interest rate, were less than one-tenth of my monthly gross income. And in just 10 years I had paid off all of my student loans. By then I already owned a house, a car, and was giving birth to my second child.
If only it were this easy for students and families today. Even before the current financial crisis I worried about what the future would hold for my own 3 daughters. Having been privy to reams of student loan data in my prior corporate finance career, I had a bird’s eye view of the looming borrowing crisis unfolding for young people today. I could foresee the challenges that would confront this generation down the road and wondered how we corporate finance professionals, issuing certificates backed by pools of student loans, could possibly predict loan defaults in such unchartered waters. With the rising cost of college, students were carrying loan balances far greater than anything we had experienced before. Additionally, loan repayment schedules now stretched out over much longer periods of time as compared to the traditional 10 year school loan of former years.
I looked at these student loan portfolios and wondered what types of jobs these young borrowers would be able to secure in order to not only pay off their loans, but also realize the American dream of owning a home, having a family and being able to see their own children attend college. These questions brought back my own anguished feelings of 20-some years before, when I had to come to terms with my own debts. Yes, my earnings rose each year while my loan payments were fixed, but my expenses kept pace with my salary increases. I soon had mortgage payments, property taxes to pay, and other people to feed, clothe, and educate.
When I made the decision to abandon my music career and go to business school, it was a choice made largely on practicality and not for any great love of business, though I was good in math and always liked numbers. I figured that an MBA would open up many opportunities and I would no doubt find something fulfilling. I knew that whatever field I chose, I would probably need more education, and I was aware that being able to pay back loans and to support myself had to factor into my decision. As an educational consultant, I do not advise young people to choose careers this way, though financial responsibility still needs to be part of the equation. Sadly, this is rarely a consideration for students today. Many students finance the full cost of their education with loans without giving any thought to whether their chosen career will offer the necessary income to actually pay off their debts and still buy a car, a house, support a family.
Did we as parents tell our sons and daughters that it’s okay to mortgage our futures with no strategy or thought to how we might pay the loans back? Certainly that is one object lesson we have unwittingly taught to our children. Don’t get me wrong. Without the ability to borrow, few of us would be able to buy homes, cars and yes, pay for college. Nevertheless, the attitude that just about anything is affordable with a credit card has turned us into a society of debtors. While I am not professing to say anything new, I too often worry that our children, who will bear most of the burden of the mess we’ve created, are ill-prepared to understand the concept of delayed gratification and living within one’s means. Our conspicuous consumption of the past decade has also contributed to our children’s obliviousness to financial responsibility.
The one bit of good news coming out of this economic mess and escalating cost of college is that some educators are starting to realize the need for more formalized training in our schools on financial literacy, teaching our children basic skills such as creating and living within a budget, balancing a checking account, understanding borrowing concepts such as loan-to-value and affordability, contributing to savings, etc. While it is encouraging that educators are catching on, we as parents need to instill some of these responsibilities and skills at home. Have the conversation about managing debt before everyone racks up too much in order to attend that dream school. Make sure your child and you understand what is affordable. A reasonable student loan payment is around 8-10% of gross monthly income. If the number is north of 12-15%, it is time to give more serious thought to the longer term trade-offs, especially when it comes to career choices and future lifestyle.
How does one determine what amount of borrowing is affordable? There are useful calculators on the web, such as those which can be found at http://www.finaid.org or http://mappingyourfuture.org. Calculators such as these will enable you to figure out whether the debt burden is too onerous, based upon expected career choice and income, the likely borrowed amount and the interest rate. Many of these calculator sites also offer tools for estimating these variables.
Teaching financial responsibility to our children is not just about paying for college. These are skills and knowledge necessary for every aspect of personal fiscal management, whether it is raising and supporting a family or planning for retirement. The golden years of rising home values and markets are gone, at least for now. This is when the lessons and practices of financial prudence really count.
Photo courtesy of uhuru1701