The pursuit of higher education in the United States is often viewed as a necessary step towards a fulfilling and well-paying career. While this may be true in those professions that require such degrees, the rising costs of education have led to an alarming trend: many students are now borrowing more for college than what they might make in their first year out of school. This financial decision can have long-lasting consequences, and here’s why you need to stop borrowing more for college than your annual salary.
The Current State of Student Loans
In the quest for a quality education, student loans have become an essential tool for most students as the cost for college continues to escalate beyond what most students and their families can afford.
As a result, the average student loan debt is now around $30,000, and in many cases, it exceeds the average starting salary for new graduates. This disparity has created a financial burden that undoubtedly will be felt for decades.
In addition to other financial considerations, the increase in housing costs in particular is putting the ability of students being able to start out their financial futures on solid footing in serious jeopardy. In fact, with the average cost of housing now consuming close to 50% of these individual’s incomes these high fixed costs are becoming insurmountable for many.
Add to this another high fixed cost like student debt payment and it makes for a questionable situation. The following are some additional considerations that are presenting themselves as a result of this crisis:
1. Delayed Financial Growth
Borrowing more than your anticipated annual salary means that a significant portion of your income will be tied up in loan repayments. This situation can lead to delayed financial growth, limiting your ability to save for essential life milestones such as buying a home or starting a family.
These financial delays can have rippling effects that last well into middle age. This is due in large part as a result of individuals not being able to begin to invest in their 401(k)’s at an early age and forgoing not only compounding interest but securing their employers match.
2. Interest Accumulation
Student loans aren’t interest-free. The more you borrow, the more you’ll pay in interest over the life of the loan. If your loan amount exceeds your annual salary, the interest payments can become a significant financial burden, making it even harder to pay off the principal balance.
Although this situation would be a serious concern for every person, for those students without the prospects of making high incomes in their careers, this is a serious concern. Especially with the current law being that individuals cannot have student debt relieved even in a bankruptcy proceeding.
3. Limited Career Flexibility
A heavy debt burden might force you into a higher-paying job field that you’re not passionate about, just to make ends meet. Your career choices may become limited as you strive to find a position that enables you to handle your monthly loan payments. This necessity could lead you away from a fulfilling career and into a job that serves only to pay off debt.
In addition, with a high debt to income ratio graduates may be forced to have to live with family further limiting their career prospects and limiting their ability to move to high income jobs which are usually located in and around higher cost areas.
4. Impact on Credit Score
A large student loan relative to your income can affect your credit score, especially if you struggle with repayments. A lower credit score can hinder your ability to secure other loans, such as a mortgage or car loan, impacting many aspects of your adult life.
A distressed credit score also comes into play at the point that a graduate wants to venture out into their own apartment. With a low credit score the individual will either pay a much higher premium in the form of a large security deposit or an increase in monthly rent payments. This will result in a further compromised financial condition for the graduate and an inability to save and invest.
5. Emotional Stress
The mental and emotional toll of carrying a large student loan can be overwhelming. The constant worry about making payments can lead to stress, anxiety, and other mental health issues. This emotional weight can affect an individuals overall well-being and quality of life.
This just compounds the effect of what many of these students already experienced during and after COVID-19. Although some stress is part of the human condition of course, permanent and substantial daily stress is simply not a favorable environment to be in.
6. Potential for Default
If your student loan payments are too high relative to your income, you may find yourself in a position where defaulting on the loan becomes a real possibility. Defaulting can have severe consequences, including wage garnishment, tax refund seizures, and a further drop in your credit score.
As mentioned, with student debt not eligible to be eliminated through bankruptcy in the US it becomes a much more serious situation for the potential for default as student debt consumes a much larger portion an individuals funds that can be used for debt service.
The 1-for-1 Rule
The Financial Independence community has adopted a rule that deals specifically with student debt. It establishes a ratio of debt to annual salary. More specifically, the rule identifies that an individual shouldn’t incur more than $1 dollar of student debt for EACH dollar an individual will receive in annual salary in their first job.
So for an example, if an individual is looking at a career where a job for that profession pays $35,000 per year and requires a college degree to get it then an individual shouldn’t incur more than $35,000 in total student debt to get that degree.
Unfortunately, there are too many examples where individuals have taken out student debt in dizzying amounts to go to elite schools in order to secure careers that pay a fraction of what they incurred in debt.
I personally know dozens of situations where students have gone to selective schools, like Harvard University, to become school teachers and social workers.
Certainly for those people who are being financially subsidized by their family to do this this is a conscious decision but for those who are not from affluent families, to do so would be financial suicide.
Alternatives to High Borrowing
Given the risks, it’s wise to consider alternatives to borrowing more than your anticipated annual salary for education:
Community Colleges and Trade Schools: These institutions often offer quality education at a fraction of the cost of four-year universities. In many states, community college can provide a credit for credit exchange into other state institutions and can be gained for a mere fraction of the cost.
Scholarships and Grants: Apply for financial aid that doesn’t have to be repaid. Every dollar you don’t borrow is a step towards financial freedom. What isn’t always understood by prospective students is that a lot of small private colleges offer significant tuition reduction due to substantial endowments and supporting scholarships from benefactors.
Work-Study Programs
Balancing work and study can help reduce the amount you need to borrow. In fact, my daughter went to college on a full academic scholarship for chemical engineering and as part of it, they provided her with a part-time job that paid at the rate of an entry level engineer.
As a result of not having to pay for tuition, she was able to use the money she made at her part-time job to pay for living and college expenses.
As part of the work-study program, in the Summer they provided her with a full time job that also counted for academic credit. In addition, they actually paid her a market rate hourly wage for the position for every hour she worked.
Over the four years she went to school, not only do she not have any debt and was able to pay for all of her expenses, she was able to put $15,000 away in an investment account before graduating from college.
Consider ROI
Evaluate the return on investment for your chosen field. Aim for an education that aligns with your expected income. Know the salary prospects of your expected career BEFORE you start looking at colleges.
Conclusion
Education is an investment in your future, but it should be a wise investment. Borrowing more for college than what you may earn in your first year out of school can lead to a challenging financial situation that affects many aspects of your life.
By considering alternatives and aligning your borrowing with realistic income expectations, you can pursue an education that serves your career goals without sacrificing your financial future.
Always remember, the goal is to use education as a stepping stone to a fulfilling life, not a financial anchor that holds you back.
