This is the fourth in a series this week about financial issues faced by students in college and trade schools. Yesterday’s post discussed discretionary spending. Today we share an example that can help students as they consider how much they will spend on discretionary items.
Suppose Student A and Student B are financially identical, except Student A spends $450 a month on discretionary spending and Student B spends $150 a month. Student A spends $300/month more on discretionary expenses through four years of college (I’m including summers too, since most students continue having discretionary spending through the summer). When four years are over, suppose Student B has total student loan balance of $20,000. Since they were identical except for discretionary spending, that means Student A’s total student loan debt will be $34,400, or $14,400 more than Student B.
The current interest rate on federal student loans is 3.73% per year. Let’s suppose they repay their loans using the standard 10-year repayment plan, although there are other plans available with longer repayment terms and lower monthly payments. On the 10-year plan, Student B will pay $200/month. Student A, on the other hand, will pay $345/month.
As fresh college graduates, will Student A be ready to deal with a monthly loan payment of $345, instead of a payment of $200? That extra $145 student loan payment is the consequence of their extra college spending; extra spending during college limits their options in the future. Understanding the consequences of their actions helps students make informed decisions they can live with in the long run.
What’s the “right” decision on discretionary spending? Only the student can decide. I have heard of college juniors and seniors who look back on their spending in their first one or two years of school and regret it. Of course there may be others who look back at how little they spent and wish they had let themselves have a little more fun.
When considering how much total educational debt you are willing to accumulate, consider two rules:
- Borrow as little as you can. This is in bold, because I think of this as the “golden rule” about student debt. This rule applies in virtually every situation, and is above any other rules.
- Avoid borrowing more (total) than your expected first year’s salary. This is a commonly accepted “rule of thumb.” Example: if you hope to start out as a civil engineer making $60,000, then $60,000 should be the MAXIMUM you are willing to borrow for your education.
Notice: this doesn’t mean you should go ahead and spend extra because “you can afford” to borrow $60,000. The golden rule is above all other rules – no matter what, it is wise to borrow as little as you can.
Tomorrow – the last in our series “College Students and Money.” Do you think the subject of credit cards will come up?