How Much is Too Much to Borrow for College?

Guest post by Kathy Ruby, Principal, Financial Aid Partner Success at EAB and former Dean of Financial Aid at St. Olaf College How much is too much to borrow for college? It’s a great question, isn’t it? I’m sure many students ask themselves this question as they compare aid offers and decide where to enroll. Unfortunately, we can’t answer it for you—only you and your family can make a decision about how much is too much to borrow. We at Bright Horizons College Coach^® believe that a reasonable amount of debt is a worthwhile investment in your future, and will repay itself over and over again, both monetarily and in the less quantifiable benefits that come with earning a college degree. However, as finance experts, we have had many conversations with college graduates and their families, now in the throes of repaying loans they chose to borrow. Some are successfully and (almost) painlessly repaying their loans. Some are managing repayment, but wish they had been more mindful of what they borrowed. And finally, there are some who have gotten in over their heads and regret how much they borrowed. For whatever reason, these families avoided asking themselves in the beginning, “Is this too much to borrow?” And now they are paying the price (pun intended). So, what do you need to know to figure out whether your financing plan is feasible? Let’s look at some hard questions you should ask yourself:

1. How much money will I make as I begin my career? Use the Bureau of Labor Statistics’ Occupational Outlook Handbook or a website like My Next Move to find out about median salaries and career prospects in your field. If you don’t have a particular career in mind, then do some research on what the median starting salary is for your type of degree. Ask the college or program you are considering if they have any information to help you figure this out—many colleges publish alumni outcome surveys that get at this question.
2. What if I don’t make that much? In an ideal world, you’ll finish your program and move into a booming job market. But what if you don’t? What if you change your major? (A very high percentage of students do.) What if you don’t finish your program? What if there’s a recession when you graduate? Making any financial decision entails risk, and paying for college is no exception. You are responsible for repaying the debt no matter what, and you have to be confident that you can pay it back even if things don’t go according to plan.
3. What will my monthly payments be? In today’s information-filled world, there is simply no excuse for not knowing what your monthly loan payments will be when you leave school. Use a student loan repayment calculator like this one to estimate your monthly payment. Federal student loans have fixed rates that are established July 1 of every year. Private loans and federal parent loans are generally more expensive, so assume a higher interest rate for those. The standard repayment term for federal loans is 10 years, and most programs will give you longer than that if you need it, so you can run estimates using 15, 20, and 30-year repayment terms as well (if you’re willing to still be paying off college that many years later).

   In addition to looking at the monthly payment, notice how much interest you’ll pay back over the life of the loan (for this calculator that means you have to click on the “Show/Calculate Amortization Table” button). In some cases, if you take a very long time to repay the loan (which is what you’ll need to do if a 10-year payment plan isn’t affordable!) you may pay back more than twice what you originally borrowed. Ask yourself: “Is my dream college worth it?”

4. Will my payments be affordable? We told you we weren’t going to answer this for you, didn’t we? And we meant it. However, we can give you an idea of what researchers and financial professionals say about how to manage student loan debt. Keep these suggestions in mind as you compare your potential indebtedness to your potential income:
   • Don’t borrow more in total student loans than what you think you’ll make in salary in your first year out of college.
   • Your monthly payments should be no more than 8% of what you expect your gross income will be.
   • Your monthly payments should not exceed 20% of your discretionary income. Discretionary income is defined as the income that exceeds 150% of the federal poverty level for a single person. (This suggestion comes from Sandy Baum, an independent policy analyst, and Michael McPherson, from the Spencer Foundation.)
   It’s possible that once you’ve done the math, you’ll realize that the amount you are planning to borrow exceeds these suggestions. This may still be okay, if you plan carefully. Information is power, and knowing this ahead of time will help you make appropriate lifestyle choices (for example, getting extra roommates or considering moving back in with family) when it comes time to enter repayment. It may also motivate you to find ways to cut expenses to minimize your borrowing while you’re in college.
5. Can you and your family afford to pay the accruing interest on unsubsidized loans? If the answer to this question is no, you will want to think carefully about whether you are borrowing too much. College graduates and their families are often shocked by how much their loans have grown while the student was in college, or in subsequent deferment periods, such as graduate school. If you or your parents are borrowing unsubsidized loans, even though payments may not be required while you are in deferment, interest will be accruing, and will be capitalized, or added to the principal amount before you enter repayment.

A quick way to determine the amount of interest that accrues while a student is in school is to multiply the interest rate by the loan amount and then divide by 12. While not a perfect method, it has been helpful for families who are trying to plan. Essentially, for every $1,000 of interest that accrues and is added to the principal of your loan, in a 10-year repayment plan, your required monthly payment will increase by about $10-$12 per month. The best plan is for you and your family to pay the interest as it accrues. And if you can’t, be sure you add the accrued interest to your principal amount when you calculate whether your loan debt will be affordable later on. Our intention with this post is not to scare you—borrowing to pay for college is a necessity for many, and is usually a rational financial decision. However, we hope these questions will give you the framework you need to have an honest conversation today about what will be affordable tomorrow.