The DOE Says Students Should Spend 8-10% Of Their Income on Loans. How Much Student Debt is Really Too Much?
Posted By Donna Fuscaldo on June 22, 2015 at 10:20 am
Student loan debt if a fact of life for many students. But it doesn’t have to bankrupt you once you leave college. Figuring out how much debt you can handle is a process that should start before you choose a school.
Nobody wants to be saddled with thousands of dollars in debt when they graduate college. However, that’s exactly the case for countless students around the country. And while forgoing debt to fund a college education is a pipe dream for many incoming students, understanding just how much debt is reasonable is becoming a necessary step in the school scouting process.
“The key is to reach students before the decision point and before the application stage,” says Bruce McClary, a spokesman at The National Foundation for Credit Counseling. “You have to figure out how much the full cost of college is going to be in the early stages.”
When it comes to calculating how much debt is manageable, the U.S. Department of Education has its own formula as part of its gainful employment rule. If passed, the rule would require for-profit institutions to prepare students for “gainful employment in a recognized occupation.” A program would be considered to lead to gainful employment if the annual loan payment of a typical graduate doesn’t exceed 20 percent of his or her discretionary income, or 8 percent of his or her total earnings. According to McClary, students should try to keep their student loan debt at between 8 and 10 percent of their monthly income.
Consider all the costs
Figuring out how much debt you can handle isn’t simply a matter of looking at the tuition you’ll pay over the course of four years. It also takes into account your expected average salary, as well as other costs associated with attending an institution of higher education.
“Different majors can handle different levels of debt,” says Joseph Orsolini, founder of College Aid Planners. “An engineering graduate can handle a lot more debt than a school teacher.” Orsolini says that, if possible, families should not exceed the $27,000 they can get in Federal loans to pay for college, because once they go past that, paying it back can get hard. He points to one client who came out of college with about $100,000 in student loan debt, plus a degree as a speech pathologist – which makes, on average, $42,000 a year. “Half of her take-home income goes to pay back that student loan,” says Orsolini.
Project a budget to determine your debt load
When coming up with the total cost of an education and the amount of debt they can handle, McClary says students need to take into account the costs of textbooks, transportation, rent, food and other living expenses. Once they have that figured out, they need to determine how much financial aid, grants and other free money they will qualify for. With that number in hand, they should then compare the average salary of the degree they want to pursue, and then choose a school accordingly. The last thing students want to do is attend a pricey school without taking into account their future earning potential. After all, someone graduating from Harvard with a teaching degree will likely have a tough time paying back their student loans.
“You need to be realistic about the salary ranges based on where you want to live after college,” says McClary. “Then you have to factor in your living expense and put together a projected budget that looks at all the things you will be responsible for.”
Creating that projected budget before you even apply to a school may seem like an arduous task. But without it, students can end up making bad financial decisions that they will be paying for in the years to come, McClary says. What’s more, the projected budget will give you a reality check about the major you want to pursue. While sports management may be your dream, if the cost to get that major severely outweighs your earning potential, a different major or a cheaper school may be a smarter financial decision.
Find ways to reduce the overall cost
Along with figuring out how much they can afford in loans, students should also try to find ways to bring down the total cost from the start. Pamela Yellen, president and founder of Bank on Yourself, a financial planning company, says it will be hard for students in high school to figure out how much debt they will be able to handle without the help of parents. Even if they can easily come up with a hard number, any reduction in that number means they will be better off. For one thing, Yellen says, high school students shouldn’t be encouraged to attend a particular school if they aren’t going to come out with marketable skills. What’s more, she says, families can defray some of the cost by having their child or children attend a community college for two years before switching to a four-year degree program at a more expensive institution. “Many students end up with a lifetime of debt they incurred while not learning much,” says Yellen. “That debt may disqualify them from buying a home, or saving for retirement.”