Month: December 2018

THE STRANGER

Imagine that a mysterious stranger approached you a week after your high school graduation, and made the following scary proposal:

“I want to give you a loan. And it could get huge—as much as for a house.  You can probably pay it back, but you have no guarantee.

You won’t know for sure if you can repay it until after about five years from now. Maybe not even then.

Oh, but there is one thing that is guaranteed: I will get paid back, even if I have to send you a bill until you are age 90. We may know each other for a long time.

“I realize that you do not know the first thing about finance since you just graduated, but I want you to say yes right now.”

You can imagine the mysterious stranger filing his teeth into points.

I was lucky. The stranger hawking student loans never came to see me. Between my family and my work, we had college costs figured out.

THE ASTRONOMICAL COST OF COLLEGE

The basic problem is that college costs are already high and getting worse. Massive student loan balances are just a symptom. In a recent article in the Atlantic, it is clear as a nation that we face some of the highest college prices in the developed world. These include three components: tuition, room and board, and financing costs of loans.

The article author estimates that the average college cost is about $30,000 a year when you count both students in public and private colleges.

At high-end private school the cost is higher.  Tuition and housing expenses often total over $70,000 per year. After four years, an unsubsidized student can expect to incur about $300,000 in total cost. To put it in perspective, that is more than the median house price is in the US. And yet we expect that students who have just graduated high school to make decisions about financing that are the equivalent.

You may think that all of this depressing talk about funding the high cost of college is pointless. After all, what is the alternative? In these posts, I have pointed out that you are far more likely to become a millionaire if you have attended college. If a college education gets you far more money over a lifetime isn’t it worth it? Well, yes, but ask first: does the high cost outweigh the financial benefit? You don’t always know the magnitude of the benefit, but should have a good idea about the price.

And remember, it is a double whammy. The interest cost of student loans makes the high cost of college even worse. 

THE COLLEGE/STUDENT LOAN DISASTER

Student loan debt is the second largest loan category just after mortgage debt. And the debt load is getting worse. About two million students had more than $100,000 in debt at the present writing. At a 6% interest rate and ten-year term, those students are paying roughly $1,100 per month.

Here is what is worse: three quarters of loan recipients are not paying down the loan principal. They are only paying part of the interest. If that trend holds, they may be in debt forever.

You see, with few exceptions, student loan debt must be paid back. Unlike other types of loans, they survive the bankruptcy process. In general, a student who takes on a student loan must repay it somehow.

THE REAL WORLD TRADE OFFS— SOME OPINIONS ABOUT COLLEGE FUNDING AND ATTENDANCE OPTIONS

Opinions vary widely about how to deal with the cost issue. Rather than go to experts, I talked to real-world people who have had to deal with them and whose opinions I respect.

Here is an anecdote from a friend in California I will call “Joe.” As a person who put several kids through four-year private colleges, he has now concluded that four years of ivy-covered buildings is a waste of money. He said:

“The deal of the century is community college.  There is zero return on investment from wasting your first two years in a four-year school.  You probably get better teachers in community college for entry-level courses than you do at a four year.  At a four year, they make you stay in the dorm, which sometimes costs twice as much as living off campus.  With a community college, you can stay at home and save big bucks.”

He feels that the educational value is equivalent, a view that has been reinforced by some studies from reputable researchers.

“…absolutely no employer cares where you spent your first two years of college, and in a place like California, it SIGNIFICANTLY increases your chances of attending a top-level UC your last two years of college.  To get into UC as a Frosh is nearly impossible now.

(His son’s) High school had a database (not showing names) of the test score/GPA combo of every kid in his high school and the schools they applied to.  Kids with 4.3GPAs and 1600 on SAT were getting wait listed at Berkeley.  UCLA and UC Davis weren’t much better.  If you were less than a 4.0 and 1350, your chances of getting into good UC were zero.

Interestingly, the kids from his school that went to Community College had an average 3.5 GPA and 1150 SAT.  Much higher than the kids going to (State colleges).  These families figured out that community college was a much better route to a UC and a better long-term deal than going to a state school or private school.  In fact, more kids in his (son’s) high school went to (an inexpensive out of state school) than in state.  Lower tuition (is paid) due to the Western Undergraduate Exchange program, and (they have) better room and board and a better academic program than a State school.  But many of the above average students did (a local community college).”

And in a shocking revelation, even one of my kids agrees with this logic, at least in part. Here is what the beneficiary of the Bank of Mom and Dad says:

“…if you can afford college for four years without getting into debt it’s worth it for four years. The overall experience of living on your own, being a part of clubs and activities, and the memories are priceless. But if you can’t, you won’t be worse off by going to a state school, or community college, or even studying abroad at a cheaper university. At the end of it all, it’s what you do with your degree after school that matters and who you know, not necessarily all that you learn in the classroom. And ultimately you have to weigh the cost of two hopefully more great years of college in exchange for a possible lifetime of debt.”

This opinion was shared with me AFTER I paid for five years of college from my own pocket.

IS MASSIVE STUDENT LOAN DEBT WORTH IT? USUALLY NOT.

There is no way around this: avoid student loan debt IF it is possible. Here are a few things to think about:

1. Make sure college debt costs align with a salary upon graduation that allows it to be paid it off.

For instance, if a student plans to go into a low paying major, and graduates with a starting salary of say $45,000 per year, it hardly pays to go to a high-cost private university and rack up $300,000 in debt. I know that is a silly example. Except, I have heard of students doing that.

2. Fully understand the cheaper alternatives and consider them.

Parents and kids have to do some homework. For instance, living with Mom and Dad may not be what students have in mind, but it saves a lot of money. Think of it as saving around $60-$75,000 in room and board and around $800 a month in loan charges upon graduation.

The best course for many people is to go to junior college, and then on to a state school to save money. An exception would be for those amazingly talented students who get full scholarships to four year schools.

COURSES OF ACTION FOR PARENTS, STUDENTS, AND GRADUATES

What follows is hardly a comprehensive list, but it is a place to start.  

What Parents Can Do

1. Be a good example yourself long before your kid goes to college–why should your child listen to you if you never consider the long term and spend money without thinking?

2. Invest in a 529 plan for your kids. It varies by state, but the idea is this: your savings and interest grow tax-free until you spend it at a state college. Even putting away as few as a few thousand dollars a year helps. Remember, though the massive estimated cost of $120,000 seems like a lot to fork over, it is much easier when you contribute $2-3,000 a year. All those savings can add up, especially when the returns compound tax-free.

Finally, imagine helping your kids earn interest for their own savings rather than paying interest to someone else. Help them for the rest of their lives.

3. Make it real–establish a reasonable limit for what you will spend for college. Then stick to it. When cost becomes their cost, they act differently. Discourage student loans unless there is an alternative.

4. Make it real again–point out what student debt will cost—right up front. An example: $70,000 cost of just ONE year at an expensive private college will work out to a student loan payment of about $800 per month for ten years at 6% interest.

5. Avoid debt in the first place–figure out how to cut the cost of college. Some ideas:

–community college

–have kids live at home during college (if that is an option)

–consider cheaper alternatives—for example, college online, with courses that transfer to 4-year colleges.

–go to a local college part-time

–consider having kids work part-time to help with the cost

6. Make a deal with your kids. If there are college savings they help with, save it, and split it with them. Consider giving your kids those savings AFTER they graduate. With luck, they will work and put the extra amount into good investments.

7. Help your kids become realistic. Not everyone should go to college in the first place.

8. Avoid taking on debt yourself. It must be paid back and can hamper your ability to retire.

What Students Can Do

1. Look into attending a community college for two years (but make sure the classes you take will transfer to a university you want to attend). Sometimes class availability is a problem. Check first.

2. Consider getting an education abroad. Some colleges in Europe are only a couple thousand dollars per year, and housing expenses and food expenses are cheaper in certain places too.

3. Figure out whether your high-cost aspirational school is worth it. Yes going to that highly ranked prestigious school sounds great. All your friends will be impressed. But if you have read this post, you know there is a downside. And if you put that extra cost burden on your family, be sure they can afford it, or it is worth it if a debt is involved. Ask yourself, if this was your money, would you make the same decision? If not, don’t tap the bank of Mom and Dad, or put yourself in debt.

What Those With Student Debt (Graduates) Can Do

1. Save some money– Live with housemates, even live with roommates. One survivor told me,

“Don’t go out to eat, make your own meals and don’t buy coffee.  Make your own at home. While this all seems like small potatoes, it adds up to thousands for a year and could help to pay for student debt. The resources available on the Internet for saving money are nearly endless.”

2. Get some help—if your debt is overwhelming, it may be time to talk to a financial professional about options.

3. Consider loan consolidation services. Sometimes a student loan interest rate can be reduced and the overall payment reduced.

4. Consider student debt forgiveness. Until now, this has been next to impossible, but the situation is changing.

5. Consider changing your loan repayment plan to one based on income.

6. Never defer payments unless there is no alternative. It makes interest accrue on the money you owe, which only makes payback more expensive.

 

Photo Credit: Wikimedia Commons: Akademische_Feier_accadis_Bad_Hambourg

Disclaimer: consult with a financial professional before taking any steps outlined here. Not all advice is suitable for your circumstances or investment style.