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Zac Bissonnette

Zac Bissonnette

Posted: April 27, 2010 03:42 PM

Why College Is a Terrible Investment to Finance With Loans

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According to the latest data (PDF) from The College Board, two-thirds of college students are graduating with student loans -- with 25% of those who borrowed owing more than $30,500.

Tuesday on DailyFinance, I discussed the data showing just a few of the lifestyle ramifications for students who borrow even average amounts to finance undergraduate education: inability to attend graduate school, taking high-paying jobs out of necessity instead of pursuing the careers they're most passionate about, and delays in starting a family and buying a house.

Still, The College Board notes that "Borrowing for college is a wise investment for most students" and many parents will remain unconvinced by arguments against borrowing for college.

But hey: you don't have to listen to me. Milton Friedman, the man The Economist called "the most influential economist of the second half of the 20th century... possibly of all of it" opined on student loans way back in 1955. He wrote of the "inappropriateness of fixed money loans to finance investment in training. Such an investment necessarily involves much risk. The average expected return may be high, but there is wide variation about the average."

May 1st is the deadline many colleges set for families to send deposits to secure a place in the freshman class. Before you opt for a debt-financed degree from an expensive college when you might be able to pay cash for a cheaper public option, consider these three reasons that while college is a great investment and debt isn't always bad, college as an investment is uniquely poorly suited to debt financing:

There's no collateral to sell off if you realize you over-borrowed. Let's say you take out a loan to buy a BMW and then, a few months later, realize that you really can't afford it. You can sell the car. You'll take a loss and, depending on how much you financed, you might have to take out a loan to get out from under the car. Students loans are just like a mortgage or car loan except that there is no asset to sell if you realize you can't afford them.

Student loans cannot be discharged in bankruptcy. Unlike virtually every other form of debt in the United States, bankruptcy will generally not help you get out from under a student loan. Elizabeth Warren, a Harvard Law School professor and consumer law expert, once said that "Student-loan debt collectors have power that would make a mobster envious." If you default on a student loan, penalties and collection fees will stack up -- and debt collectors can garnish your wages, Social Security, and tax refunds, and there is no statute of limitations on student loan collections.

An unreliable income stream. When you purchase an investment property with a fixed rate loan, you can long to a long track record of the unit's rental history and local vacancy rates. With student loans, 17- and 18-year olds are signing up for debt based on their ability to make payments from an income stream that's at least four years away -- in a career that they haven't even decided on yet. Student loan experts often suggest that students cap their borrowing a one times their expected starting salary. Back in 2009, FinAid.org expert Mark Kantrowitz suggested that students look into the expected starting salary for their careers to decide how much they can borrow. "The key rule of thumb is not to borrow more than your starting salary," he said. I wonder what Mr. Kantrowitz, whose site is an excellent resource notwithstanding our disagreement about this rule of thumb, would say to the more than half of college graduates under age 25 who are working at jobs that don't require a college degree. Oops?

Please: before you sign up for any student loans, discuss the ramifications of debt with your family, and explore other alternatives. And don't think that than an undergraduate degree from an elite private institution is necessary for a successful career. Remember the words of Warren Buffett, a proud alum of the University of Nebraska: "I don't care where someone went to school, and that never caused me to hire anyone or buy a business."

 
 
 

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