How much is too much to borrow for college?
By Joe Messinger, CFP®
July 26, 2019
For most families, student loans must be part of the college funding conversation. Through careful planning to include smart savings, tax considerations, college choice, cash flow, scholarships, and other mechanisms, families can minimize the amount of debt their students take on. How much debt is too much though? How can families make smart choices about loan debt levels in the overall college planning picture? How much can a student afford to borrow to pay for college?
Believe it or not “more than 2.5 million borrowers have student loan debt greater than $100,000.” How is debt level this high ever a good idea?! Well, it could be, but here’s the catch. When we talk about smart student loan debt levels, we look to the future and see what that student’s first job will look like. The smartest debt level depends on a student’s future salary.
Why starting salary is part of the conversation?
We recommend families use the estimated annual starting salary for the future graduate as the maximum amount of student loan debt–for all four years. Let’s look at an example. If a student wants to be an accountant, we can look up their average starting salary online at salary.com. You can include the preferred city as well since salaries can vary greatly by location.
In Columbus, OH, the average salary for “Accountant I” is $52,910. We use that figure as an estimated maximum student loan amount total for the whole four years of college, or $13,228 per year.
One of the keys for people to understand about student loans is that we base our metric on paying the loans off on a standard 10-year repayment plan. If we are paying off $52,910, that would be an estimated $561 per month using 10 years at 5% interest. Studentloanhero.com has helpful calculators for a variety of purposes like calculating monthly payments or interest amounts or prepayment figures.
Time out for an important point here…
Federal student loan amounts are capped at a certain amount each year–$5,500 freshman year, $6,500 sophomore year, $7,500 junior and senior year for a total of $27,000.
So, if we are borrowing more than $27,000 as in our example, than private loans will be part of the conversation. The interest rates for private loans can cover a wide range based on credit score, etc. Nerdwallet listed fixed APR ranges of approximately 5% to 13% recently.
As a result, the private loan repayment amount will be different from our $561 total per month estimate above, but that amount can be used for general purposes.
Teach our kids
An important exercise is teaching students about monthly budgeting BEFORE they agree to a student loan. We have a helpful blog with a budget worksheet here.
Is a student comfortable with a $561 chunk allocated to a loan payment for the 10 years after college? When students see what the other demands on their monthly budget will be, that consideration can have a huge impact on the choice of where to go to college.
Beware repayment plans
If a student takes out more in loans than they can afford, the only option under federal loans is a repayment plan which can stretch out the payments over an extended period–25 years or more.
As a result, students will pay three times as much interest, not to mention be in debt until they are almost 50 years old.
The key is to look at how much total student loan debt for all four years is required at a chosen college and understand what those payments will look like every month after graduation. The college dream can become a college nightmare if student loan debt is too great a burden. Remember our handy guideline–maximum student loan debt equal to estimated annual starting salary. This guideline will keep your monthly payment at a comfortable level.