We have all watched the U.S. debt markets grind to an exasperating halt in the last three years. It started with the auction rate securities markets, then the corporate debt markets, then the mortgage markets and then other asset-backed securities markets. Like a huge power-generator winding down, the sinking hum told us that the plug had been pulled on the U.S. debt party.
However, just as we were packing up the mirrored ball and smoke machines, we heard a loud thumping down the hall. And with a short walk and slight push of the door we found ourselves staring at a euphoric sea of college students moshing to possibly the biggest debt party of all -- student loans. Better than happy hour, these loans are essentially free up front. Just head up to the bar, look cute and "presto" here's $25,000 to get your academic funk on.
While the party analogy approaches hyperbole, many elements approach reality. The student loan debt markets are alive and well and they may just be the next lending vehicle to explode all over our newly pressed, Obama-stimulated dress shirt. According to the most-recent lending numbers from the Department of Education, federal student loan disbursements were up $75.1 billion (25% year over year) from 2008 to 2009. By some estimates student loans surpassed credit card debt for the first time this year. And, just like credit cards, these loans and their state and private counterparts enjoy a healthy secondary market that fosters their liquidity and keeps the loans cheap. This in turn keeps students borrowing and the student loan party humming.
Even the most prudent students ask themselves, "Should I jump in or just watch from afar?" "Oh, but it looks so fun," a little voice says. Because it is easy money, it is fun; but another little voice needs to tell you -- students and parents alike -- about some of the risks. Yes, student loans allow you to party now, but the hangover is very real, possibly even debilitating to your financial future. In the vein of caveat emptor, here are the biggest risks that face any student getting ready to swan dive into the student loan mosh pit:
1. Student Loans make future borrowing more costly. This is often a shock to ex-college students loaded with student debt. They take student loans without considering that it is "debt" that will affect their ability to get car loans, house loans or any other personal loans in the future. Even if you think you can afford new debt payments, many lenders will not lend to you because you are carrying too much debt. Even if they give you the loan, your interest rate on that loan will typically be higher due to your higher debt-to-income ratio. The Journal of Student Financial Aid, recommends that a student's monthly debt payments should not exceed 8% of the student's income after graduation. The problem is that most students have no idea what they will make after graduation, so forecasting on the low-side of your earning potential is prudent.
2. You cannot walk away from your student loans. I once had a professor tell me that college was a place to get knocked down so that the institution could help you get back up. The idea is that college is a nurturing place, where you make mistakes, learn from them and avoid making them in the real world. Certainly, this professor was not talking about student loans. If you make the "mistake" of assuming too much student debt and, thus, fail to repay it, our nurturing government has a number of tools to bludgeon you with. They can take your tax refunds, garnish your paychecks, take your federal benefits, sue you and/or destroy your credit. To add insult to injury, most student loans cannot be discharged in bankruptcy.
3. Co-signing parents are responsible for *all* of your debt. Many students look at co-signing as something akin to getting permission for a spring-break in Cabo. To the contrary, by co-signing for your loan, your parents are signing up to pay-in-full any amount you fail to pay on your student loans. Some students may think, "Cool!" but, in the words of Bill Cosby, your parents brought you into this world and they can take you out.
4. Not all loans are created equal. Many people research federal student loans and assume that private student loans operate similarly. This is not the case. Federal loans have fixed, low and sometimes subsidized interest rates (currently at 2% to 8% depending on need). They also often offer flexible repayment, deferment and consolidation options. Private loans on the other hand are a mixed-bag. They have higher interest rates than federal loans and those rates are often variable. Private loans are seldom flexible regarding repayment or forbearance and do not offer consolidation options. Private loans can also have interest rates as high as many credit cards (15%+) and yet most people would never put tuition on their credit card.
5. Student loan debt can survive the death of the student. If co-signing were not enough, many private student loan agreements require that the family is on the hook in the event that the student dies or is otherwise incapacitated. This has led to some heart-wrenching stories of families who are grieving over the death of a loved one having to pay their loved one's student loans as well. Make sure you ask lenders about these clauses in advance and understand exactly how they work.
In their purest form, student loans are a noble vehicle enabling us to be a more educated nation. However, when money is involved, nobility can often take a back seat. Do your research up front, understand the amount and type of debt you are assuming and feel free to party -- just party smartly. Unfortunately in the student loan world, there is no cab to take you home and the hangover can last a lifetime.
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