08/02/2009 05:12 am ET Updated May 25, 2011

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.