by Kevin Worthley, CFP, CDFA
For most students, going to college has become a near-necessity in the transition from childhood to self sufficient adulthood and their career path. Unfortunately, standing squarely in the middle of the path, like a tall NJ concrete barrier, is the ever rising cost of college. By some measures, the cost of college has risen 5 to 6 percent annually over the past decade and the average cost of attendance has doubled from 2000 to 2011.
In contrast to this rising trend, family incomes in the U.S. have stagnated over the past decade and may even be declining. This, plus the more limited capacity of governments to offer financial aid, is causing students and their families to finance college costs through obtaining loans, either by parental loans, student loans, or both. If the student and parents are not careful about how much the student is borrowing (and what their loan repayments after college could entail), the student may end college with a debt load they may have extreme difficulty paying back, and this debt is not allowed to be discharged in a bankruptcy.
Do calculate total amount of debt
While contemplating your college choice, calculate the total amount of debt you expect to incur by attending that college and what your payments would look like. Once you have your financial aid award letters, look at the loans within the award. These could include Stafford and Perkins Federal loans andparent PLUS loans. Using an online loan calculator, determine what your total balance of each type of loan might be after four years and what your monthly payments would be if your repayment period was 10, 15 or 20 years. This could be helpful in determining if you can afford the payments after you graduate from one school versus another. Consult a financial professional to help you if needed.
Do consider your career path
Consider the career path you’re choosing. What could be your starting salary? Can you afford the payments on your student loans after graduation? Now that you have determined what your payments look like, will you be able to earn enough after graduation to afford them? Take your starting salary and calculate what federal and state taxes you might pay at that annual salary. Divide the result by 12. That’s your “after-tax” income. You’ll need to pay rent, utility bills, car payments and also buy food and clothing. After all of these necessities, what do you have left for student loan payments?
Do calculate your loan payment limit
Determine if your loan payments could be more than 10 to 15% of your after-tax monthly income after graduation. If so, it could mean you’ll be "in over your head”. Consider alternate, less expensive college choices or alternate means of paying for college without borrowing. Is working part-time while in college possible? Would you be able to attend college half-time (ex. night classes) while working to support yourself and paying for classes as you take them?
Do exhaust federal loans first
Make sure you borrow first from lower-interest fixed federal loan programs before you consider private student loans, which are generally at much higher and variable interest rates. Fixed rates are better than variable, especially as interest rates are historically low now; they may go up a lot at some point in the future, meaning monthly private student loan payments could be higher. Also, it could be easier to consolidate federal loans than private loans in the future.
Do pay down private loans first
If you must borrow via private student loans, try to pay these down to zero first before the federal loans. Like most other kinds of consumer debt (e.g. credit cards), to whittle down your debt load, it is generally recommended to tackle the most expensive (highest interest) debt first. Making sure you pay all monthly minimum payments on all your loans and then, if you can pay extra principal, do so with your private student loan balances first, then the next most expensive student loans and work your way down.
Do not lose your loan documentation
Keep your loan documentation organized in file folders and make sure you keep track of when your loans are transferred to loan servicing companies (yes, they can do this and they will). If you consolidate, make sure you keep track of which loans were consolidated as well as the new terms and the new lender or new service company. Many students get confused over which loans they have, the payments and the terms. Remain organized.
Do not miss or make late payments
When your payments begin, don’t miss or be late with a payment. Some programs offer a discount on the interest rate if you make 24 or 36 on-time payments. Set up an automatic payment from your checking account (and be sure there’s a sufficient balance to cover the payment each month). A good student loan payment history can be the basis for a good credit score later (such as when you’re seeking a car loan or mortgage for a first time home purchase). Conversely, a poor payment history could result in the opposite.
Do not ignore loan servicing companies
Don’t ignore calls or letters from student loan servicing companies. These collectors can make your life miserable if you are negligent with payments. Never forget that student loans are not dischargeable in bankruptcy. Delinquent student loans can adversely affect your credit rating for a long time and in extreme cases, especially with federal student loans, your wages could be garnished to force repayment. Student loan borrowing is serious business! If you’re having trouble with payments, try to discuss alternative payment options with the lender or servicing company. It may not work (they may insist you stick with the payment plan you have), but if you are earnest about repaying your loan, they may work with you rather than have you default or continue with missing or late payments.
Do not forget to consolidate after graduation
Don’t forget to try to consolidate your federal loans and separately consolidate your private loans after you graduate. Sometimes consolidation can make repayment more affordable (cash flow wise) while you’re launching your career.
As in most other personal finance matters, planning ahead is usually a worthwhile effort. It may involve more factors in your college decision, but with the cost of college so high today, families and students need to consider how workable the debt burden will be on the student’s future. Often, working with a financial professional (financial planner or accountant) can be helpful in calculating future payments and affordability. Too many students today are struggling with $50,000 to $100,000 or more in loan debt and wish they had been more thoughtful and aware of how much they were borrowing. Avoid falling into the same trap and learn from their mistakes.