College Students, How Much Are You Borrowing?

Sure, interest rates on student loans could cost more but what about the larger impact on the global economy that goes beyond the personal bottom line?

You may recall that recently the stale-mated Congress finally came out with a “permanent” solution to a temporary fix for interest rates on subsidized student loans brokered last summer.  You may recall that a plan that allowed for Stafford subsidized loans to be set at 3.4%  was set to expire on July 1, 2012. At the final hour, Congress decided to extend the program for one year effectively deferring the issue to this summer.

When July 1, 2013 came and went without a deal on student loans, interest rates on subsidized Stafford loans effectively doubled to 6.8%.  Stafford loans are the most commonly used tools for parents and students to pay for college. This loan program helps over seven million students who qualify for financial aid assistance each year and this interest rate increase would cost each borrower thousands of dollars per loan.

Within the past few weeks the Senate approved a plan to change the student loan program, dropping interest rates retroactively back to the first of July. Moving forward, the interest rates will be tied to the market.  While it will allow for interest rate hikes, they will have caps like Adjustable Rate Mortgages ranging from 8.25% for undergraduates to 10.5% for parent loans. In our current low interest rate environment these caps won’t come into play in the near future but as the economy improves, interest rates will rise and so will the cost of money for college.

For example, a student loan of $30,000 at 3.4% would cost a borrower $316 per month. However, if interest rates increased to 6.8% it would cost that same borrower $363 per month, a monthly increase of $47 and a total increase in the cost of borrowing of $5,640.  The focus over the past year has been on the burden that this interest rate increase would have on individuals having to pay this increased monthly amount.  However,  I believe a more important aspect is the impact of higher rates on a future graduate’s ability to get into the economic mainstream.

Let’s face it.  Every dollar increase in monthly debt means less disposable income to buy a car or save for the down payment on a new home after college.  Young adults who have difficulty making ends meet are less likely to form their own household and start families of their own. To gain a sense of this, you can read the recent BusinessWeek cover story on being young, Greek and unemployed.  But you don’t have to look as far away as Greece to see evidence of the impact of “boomerang” students.  All of this has serious implications for our broader economy.

There is no question that an increase in interest payments of $47 per month is substantial and something that would be a burden on many people. At the root of this problem is the amount of money that is borrowed. A $30,000 loan was the example I used. However, there are thousands of people with loan balances far in excess of this and I don’t believe it necessarily has to be this way.

In a world and economy filled with high rates of unemployment, underemployment, college graduates living at home with their parents and individuals with tens of thousands of dollars in student loans working two and three part time jobs to make ends meet, you may be tempted to question the “return on investment” that individuals are receiving from their college degree. This isn’t to suggest that we don’t encourage our children to go to college but it is to state that the cost to which a family agrees to pay should be questioned.

Sticker price, cost of attendance and cost per credit hour are all terms that are used to describe the expense associated with a college education. When looked at individually, this can be misleading. In fact, in recent years colleges have been required to place net cost calculators on their websites so that a family can determine the actual out of pocket cost that a year of school will be for that individual from that institution.

This is a great first step forward because the actual cost will vary from student to student based on a variety of factors including grades, test scores, financial need, athletic abilities as well as many other things. A net price calculator will help sort through all of this. Yet it will not help a student compare one institution to another. Obviously, the costs of colleges vary dramatically and so will the offers that they give to a student. In other words, some colleges will offer you a better deal than others. It is critical to compare each net offer side by side to other offers you have received.

Time to Graduate: More Important Than Price

Additionally, to maximize your return on investment you should be looking at the average number of years a degree takes to earn from the schools you are considering. A school that takes an average of six years to complete a degree (not uncommon for many public colleges) may have a very attractive annual cost. Yet a school that might have a slightly higher annual cost but graduates a high percentage in four years may be a much better value.

Simply do the math:  Spend $18,000 per year for a public school for six years that doesn’t provide you with any grant aid and you’re out of pocket about $108,000 not accounting for inflation.  Go to a school with a better than average rate of completion in four years at a price tag of $45,000 and 75% covered by grant aid, and you’ll be out of pocket about $45,000.

Interest rates on student loans is important but the amount of money that must be borrowed is the critical issue. The less money that is borrowed the smaller the impact from any interest rate changes. And the better for every family’s personal bottom line.