How High is Too High for the Cost of Higher Education?

Once upon a time there was a nice clean line between "bad debt" and "good debt." Bad debt was money you borrowed for expendable items (think: clothes and consumer electronics). Good debt was money you borrowed for assets that would go up in value over time (think: housing and education). We all know what happened to housing, but what about education? For years the subliminal messaging most of us received was that "no price tag is too high for a quality higher education." As we rethink virtually everything in this post-AIG, post-Madoff, post-housing bubble world, it may be time to ask if that graduation cap tassel is really worth the financial hassle.

Let's examine the facts. The idea behind higher education, from a purely financial stand point is this: In return for spending some money now, you receive an education that will enable you to earn significantly more than you would without that education... and enough to comfortably pay back those loans. The first half of that statement remains true. US Census Bureau data shows that those with college or graduate degrees, on average, earn significantly more than those without. The second part of the statement, however, gets muddier. That's because over recent years the cost of higher education has grown much more rapidly than wages. As a result, the old recipe for measuring "good debt" in the educational arena isn't working. In the wake of this recession, millions of hard-working Americans are struggling to pay back student loans. Washington has stepped in with income based repayment plans taking effect in July -- but that still begs the question:

How high is too high a price tag for higher education to begin with?

After crunching some numbers we'd argue that in an ideal world, the total amount of student loans you would take out would not exceed your expected average income over your first 10 years out of school.

In plain English, if your academic interests lead you to think your ultimate career path will result in an average annual income of $50,000... then $50,000 is the maximum amount of loans you would want to take out. What's the rationale behind this? It has to do with paying those loans back. If you have more than 10 years of spending 10% of your gross income on student loan repayment, it will crimp your ability to save for other life objectives such as a home or car down payment. Where did that rule of thumb come from? Well, if your gross (pre-tax) income is 100% of what you have to spend and Uncle Sam takes (on average) 25% of that, you are left with 75% for all of the rest of your living expenses. In an ideal world, you'd be saving 15% of your gross income for the future. That leaves you with 60% to spend on your current life. If more than 10% of your income is going to student loan repayment you are now left with less than 50% for everything else.

This is not a hard and fast rule of thumb but rather a guidepost. As with all things financial, there are trade-offs. The education of your choice may make you so exquisitely happy that you don't mind paying those loans off for 25 years. The key is to be informed about what you are signing up for if you take out more in loans than you think you will earn on average, annual out of school. A $150,000 graduate education for a job that ultimately pays $35,000 a year (and this happens!) is a recipe for an extreme financial trade-offs. This doesn't mean you shouldn't do it, but it does mean you should understand the financial consequences of this choice ahead of time. We're not saying it's right that education costs have sky-rocketed. We think it's awful and that as a nation we need to think long and hard about how to provide quality education at reasonable prices to all who are hungry to learn. Rather, our point with this piece is to help students see ahead of time -- given current realities -- what they might be in for financially if they don't think through the ramifications of the student loans they take on.

The key with higher education costs is to look at them with the same critical eye that we Americans are looking at everything today. Only you can decide what the right answer is for your situation -- but being armed with the tools to think through the pros and cons before you sign on the dotted line of a student loan helps to put you back in the driver's seat.

Manisha Thakor and Sharon Kedar are the co-authors of ON MY OWN TWO FEET: a modern girl's guide to personal finance.

Follow Manisha Thakor and Sharon Kedar on Twitter: www.twitter.com/ManishaThakor

Comments

[DosGatos2]

I remember a time when student loans were only available through the federal government at very low rates. By privatizing student loans, we enabled banks to make a lot of money by charging rates well above the federal interest rate. Then, those same banks went to Congress and demanded that student loans not be dischargeable in bankruptcy--despite the facts that the loans were federally guaranteed so banks could not lose a dime!

Private student loans from banks area variation on the theme of financial innovation like NINJA loans and exploding ARMS and, coupled with the increasing costs of tuition itself, have kept people from pursuing higher education. In a global economy however, the best thing a nation can have is an educated populace to attract jobs and investment.

The bottom line is that higher education should be free. It's in the best interests of the nation, and in the best interests of future generations. Don't look back to the good old days of a manufacturing based economy--those jobs have largely gone away to countries that the US cannot compete with based on cost.

[collegeloanconsultant]

The new monthly payment formula in the income-based repayment plan for federal loans is public policy-making which discourages students from thinking about the actual value of their chosen degrees.

When repayment will be based solely on income/family size rather than total debt, does it really matter what your education cost?

[bannorhill]

You make some good points, however, you miss one fundamental fact. Financial aid!!!!! Harvard, Yale, Princeton, and other $50,000 a year schools set the"list" price high knowing the rich can and will pay. They can afford it. The others are given financial aid in the form of grants, loans, and work.

To properly access the real cost of education you need to look at the real out of packet cost. In almost all cases it is NOT the $50,000 a year but something less. What is your debt at graduation? If you pay $10,000 a year and have another $5,000 a year in loans your real cost is $60,000 for 4 years. With an engineering degree you can start a over $50,000 a year compared to a $10 an hour job without the degree earning $20,000 a year. You pay for the difference in 2 years.

Education is an investment in yourself. If you invest wisely it will pay off with large rewards.

[cdrach]

this emphasis(over?) on higher education began when we moved to a service economy and stopped producing actual "Stuff" that people can use. the kids that are graduating now are going right to grad school and getting their masters because of the dearth of jobs and getting deeper into debt. all that education and no one to boss around in the future BECAUSE THE US PRODUCES NOTHING BUT BANKERS AND LAWYERS

[Trebor1]

Did you consider the likelihood of an "unconnected" person obtaiing obne of these apprenticeships? By "unconnected" I mean an individual who is not the child of a contractor or union member. If you took into account the number of available apprenticeships vs. the number of applicants for these apprenticeships, you would see that, on a percentage basis, it is easier to get into law shool or medical school than it is to get into a joint union/management apprenticeship.

I wouldn't skip college in the hope of obtaining an apprenticeship -- unless daddy was a contractor or a union official in the trade to for I was applying.

[bannorhill]

At my son's school over 50% of the students have either job shadowing weeks or apprenticeships. If you are in a Major that is in demand the job apprenticeships ARE available. If you are majoring in basket weaving the apprenticeships are at the Golden Arches.

[Hdaryl01]

I wrote a Thesis on this very topic in 1996. Education has, as you point out, become much more expensive in relative terms since then, so my findings are even more pronounced today. My research indicated that under our current system, a non-college educated union tradesperson actually out earned the average lawyer or MBA in economic benefit over his/her lifetime.

Why? At 18 the tradesperson is earning money as a journeyman apprentice in a trade program. 401K investment and other retirement funding begins at 18. Virtually $0 in education expenses. 0 opportunity cost years "invested" in non-income generating education (that costs huge). These folks are much more prone to buying a house much earlier-mortgage interest deduction. And, getting married earlier and raising a family-tax deductions. In sum, by 25 when the average lawyer today graduates with $150K in student loan debt, $0 income for the 7 years spent in undergraduate and law school, no retirement funding, etc., many of these tradespeople are long time homeowners, generating significant income, with significant deductions, 7 years of retirement funding, and no debt. Tradespeople will make significant income, and with deductions, will be part of the 60% of Americans that pay virtually no Federal Income Tax. Lawyers MAY come out of law school and make 6 figures-as much as $160K first year. This puts them in the non-deductibility of student loan interest income level, and the highest tax bracket, typically with no home interest deduction, etc.....

[anshumanmishra]

Interesting. I would love to read more about this; could you provide a link to your thesis?

TIA.

[Indra]

There will be fewer people going on to college. Many will opt out for shorter period training in some skill areas that do not require the traditional college pattern. Colleges will offer trimmed down 2 1/2 to 3 year BA and BS degrees. In general most degrees are not worth the paper they are printed on anyways. Only degrees from the most prestigious and expensive schools will get you into the right environment to make good money. The expense will not go away. The situation willl continue to deteriorate.

[phree]

Agreed, but Americans mistakenly believe that there can be no balance b/w competition and cooperation (although many exceptions are relevant). Some believe that health care is a privilege and not a right; this is a fundamental flaw in recognizing the humanity of the other. It makes all other forms of oppression and violence possible. If the other can be represented in a "less than" worthy mode, then we are consciously authorizing a brutal form of economic cleansing that produces death for the uninsured.

[mbaty]

In some countries people are given the opportunity to attend higher education courses for free. We are still arguing about whether everyone should be taken care of when they are sick. How valuable is it to have an educated populace? We have to start thinking beyond money if we want to create a great society, and that involves higher education. What are the real costs beyond dollar signs? What is the actual benefit to society beyond what it costs now? This goes beyond higher education, but if we are to preserve our universities and colleges we may have to realize that their benefit cannot be fully measured in dollars and cents.