Student Loans and Us

I have a lot of mixed feelings about student loans. The topic has been debated back and forth in the media and in local conversations a lot since the recession, yet I don't think that there is any source that covers all of the nuance of the subject. 

This post is not going to do that either, but I did want to share some random thoughts. 

First, you really have to look at student loans as an instrument, or a tool, to achieving a college degree. 

It would be wonderful if college degrees were handed out to deserving students for free, but this simply isn't the case. College costs money, and in increasingly larger sums, having increased at a rate roughly double the rate of inflation for the past few decades. Watch the dotted-red line: 

Chart from D. Short -

And the cost of college is not just tuition and fees. A student needs a place to live, food to eat, funds for books, and general support during their time in school. Many are lucky and receive support from their parents, while others honorably pay their own way by either saving before or working while going to school, which is no easy task. Even others find creative ways to pay for college, like exchanging tuition for a guaranteed job and six years of active duty service as a US Army officer (this was an outstanding deal for me personally, but I realize that it isn't for everyone). Thus, the student loan problem is actually less of a student loan problem and more of a college cost problem. But that's not the topic of this post. 

Assuming that scholarships, military service, and parents generosity is unavailable, the next route is to borrow, which is where student loans come in. I am of the mind that student loans are some of the rare "okay" debt, since the ultimate purpose of student loan debt is to increase future earnings (more on that in a moment). It is usually a necessary evil, and there are tax benefits for those whose income is at or around the median household income (student loan deductions are phased out as income increases). 

Debt is debt, however, and no matter whether it is subsidized or not, loans come at a cost, and that cost is interest. Increasingly, that interest rate has been rising. I am still paying off student loan debt that my wife accumulated at the University of Louisville more than 10 years ago, but it is compounding at only 2.9% (I am not in a hurry to pay this off). In contrast, I would guess that the average student loan interest rate okay is between 8-9%, with the federally-subsidized rates coming in at a relatively modest 6.8%. 

That difference in compounding interest is incredible. For a loan that takes 10 years to pay off, at 7% interest, principal plus interest (total payments) will equal roughly double the initial loan (a $10,000 loan will need $20,000 of total payments to extinguish, ignoring any tax effects). That's the effect of compound interest (and it's much more fun when it works in your favor instead of against you). Contrast that with a loan of 3.4% of the prior decade which only increased by 50% over 10 years (a $10,000 loan would "cost" $15,000). 

By itself, that doesn't make borrowing against students loans a problem - believe me, college is still generally worth it. As I mentioned above, the purpose of taking on student loan debt is to generate higher future income. The general conclusion from most economic research I've read concludes that each additional year of schooling past high school adds about 8% to their annual lifetime earnings. Thus, someone with a college degree should expect to earn about 30% more than the average person without a college degree. 

That's what makes student loans worth it - most of the time. 

But it really depends on what college degree you're pursuing. The average per capita (each person) income in the USA in 2012 was $42,700. With that reference point, here are the average earnings for various college majors (more details here):

The bottom half of that chart generally describes where the disconnect happens. The average student loan burden is about $40,000. If you borrow that amount or even twice that at $80,000, and obtain a degree as a chemical/electrical/petroleum engineer or pharmacist, that will likely be a very good tradeoff since you'll have to work only an extra six months or so to pay that debt off since you're going to be making, on average, $80,000 per year. 

But the average earnings of a career in studio arts or early childhood education is less than half of the average of an engineer or computer science major. So racking up large sums of student loan debt to pursue a career in these areas is likely not a great financial decision, since you'd have to get lucky in order to generate the additional income to pay down your debt in a timely fashion.

I once had a conversation with a friend about this and he said that he didn't want to live in a world where his kids could only be financially solvent if they chose to be accountants or engineers. Well, I don't want that either, but facts are facts - our economy is such that rewards those with technical skills because they are rare and valuable and productive, while we have a large surplus of art history majors relative to the amount of jobs available in the field. I don't find this depressing at all - I find it realistic. If those jobs were in demand, and there weren't enough graduates to fill positions, the salaries would increase. But they don't because that's not the case. 

I'd rather people know and understanding this before racking up $200,000 of student loan debt. These are valuable and intelligent questions: what is my future earnings potential? Can I realistically pay this back? Can I even finish my degree program? Of course, there are dream jobs in every field that pay more (these figures are averages), but it's important to make decisions based on data. 

What really prompted me to write this post, though, was this article from the Wall Street Journal about how students are going into school and taking on student loan debt knowing the consequences, but doing so regardless as an alternative to working for minimum wage: 

"The only way I feel I can survive financially is by going back to school and putting myself in more student debt," says Mr. Selent, who has since added $8,000 in student debt from living expenses.

Yikes - I can't tell you how scary that is. Later in the article: 

"He is now taking courses for a degree in theater so he can become an actor."

Oh my. That is a terrible, terrible idea. I wish I could show him the chart above. 

But it gets worse - student loan debt (like payroll taxes) are one of the few things that follow you through bankrupcty. That's right - a judge can and generally does discharge credit cards and mortgage debt, but Sallie Mae will generally follow someone through Chapter 7 bankruptcy. Ouch. 

I'll end on this note - any guesses what the largest financial asset that the federal government owns? It's outstanding student loans, which make up 44% of Uncle Sam's $1.6 trillion asset sheet:

Chart from D. Short -

Chart from D. Short -

Thus, student loans on the federal balance sheet have increased about 6x since 2008. The $714 billion that Uncle Sam holds represents about half of the total student loan debt outstanding.

Most articles on student loans end with banging the table about what we should all do about it - that college should be less expensive, that loans should be cheaper, etc.

I don't really think that there is anything we can do about this, frankly. College is expensive because it's generally worth it - a 30% premium on lifetime earnings for a four-year degree is usually a good return on the investment. Student loan interest rates have increased because it is risky for financial institutions to loan money to students entering a weak job market where it's tough to get income. Forcing the government to subsidize student loans 1) is probably not politically possible, given the raging debate over government spending, 2) might have actually caused the incredible rise of college tuition in the first place by offering cheap money, guaranteed by Uncle Sam, to students.

Probably the best way to deal with the rising costs of college is to save up-front, instead of borrowing on the back end. If I can help you put together a plan to do just that, give me a call.