How to ensure your student doesn't end up with too much debt after college?
With the cost of college continuing to rise, for most families, student loans will be part of the equation when it comes to paying for college. However, through careful planning, families can minimize the amount of debt their students walk away with by utilizing strategies to optimize savings, taxes, financial aid, scholarships and cash flow.
So as a family, how do you answer the question, "How much debt is too much?"
According to recent studies, “more than 2.5 million borrowers have student loan debt greater than $100,000.” And while $100,000 might never seem like a reasonable amount of debt to take out for college, the truth is that it all depends. Depends on what you ask? Well that's where we need to do some more introspection into what you anticipate your student's future income to look like. The truth is that not all degrees are created equal, and your student's ability to pay off loans will be directly tied to their future earning potential.
So where do you start? We recommend a student take out no more in loans for all years of college than they anticipate earning in their first year of employment. So for example, if a student plans to be an engineer making $55,000/year out of college, then the total amount of loans should be capped at $55k or $13,750 per year, assuming a standard 4 year degree. This would result in a monthly payment of $583 for your student, assuming 5% interest over a standard 10 year repayment plan. You can use sites like Studentloanhero.com to find helpful calculators to play around with estimated payment amounts.
Keep in mind that if a student takes out more in loans than they can afford, and the monthly payment isn't manageable, the only option under federal loans is a repayment plan which can stretch out the payments over an extended period of 25 years or more. This will result in your student paying three times as much interest over the life of their loan.
Also, it's important to remember that federal student loans are capped at $27k over 4 years, so any amount over that would need to be borrowed using Parent PLUS loans or private loans, where the rates and terms can vary significantly, but for estimation purposes, the $583 amount is a good starting point.
So how do you decide if this amount is too much?
It all comes back to a conversation with your student, and looking at a projected budget of expenses following college, because how you can you possibly determine if $583/month is too much/too little without understanding what their other costs might be. Only then can you and your student begin to determine if they are comfortable with that amount of money being allocated to student loan payments each month. Once this monthly amount is put into the proper context, it can have a huge impact on the choice of where to go to college, to ensure you end up with a manageable result from student loan standpoint.
The college dream can become a college nightmare if student loan debt is too great a burden, but remembering our guideline of capping the loan amount at the estimated annual starting salary and making sure those payment estimates are manageable should help keep your monthly payment at a comfortable level.
Mike Bink, AAMS®, CCFS®
Mike works with families to simplify the college funding process and is widely recognized as an expert in college planning. He is passionate about empowering families to become informed consumers of higher education so that they don't pay a penny more for college than they absolutely have to.