Assess future earning power when borrowing money

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Borrowing for college can be a wise investment if it allows students to finish their education and increase their odds of success in employment and other areas of life.

But students who take on too much college debt sometimes don't realize that it can be tough to repay their loans while meeting other needs after graduation.

Questions to ask about student loans

Here are some questions to ask before taking out a student loan:

  • What is the principal amount I must repay?
  • What is the loan's interest rate?
  • What is the annual percentage rate (APR)?
  • What fees must I pay when the loan is disbursed?
  • What is the minimum monthly payment?
  • How long do I have to repay this loan?
  • What is the total amount I will repay?
  • Is the interest rate fixed or variable?
  • If it is variable, is there a cap and what would monthly payments be if the interest rate hits the cap?
  • Do I pay interest and principal while I'm in school?
  • How long is the grace period before I must start repaying the loan?
  • Do I pay a penalty if I repay the loan early?
  • What if I have trouble repaying the loan?

Source: "Helping Families Finance College: Improved Student Loan Disclosures and Counseling" by Consumers Union, July 2007.

"They're young. They have the feeling they can do anything. And there's an exhilaration that they'll be successful and student loans won't be a problem," said Bill Witbrodt, director of student financial services at Washington University in St. Louis.

"While they're in college, they want to have a great time. Why worry about loans now? That's a pervasive feeling," Mr. Witbrodt said.

For Americans of many socioeconomic backgrounds, borrowing has become a primary way to pay for higher education. But how much student loan debt is appropriate has a lot to do with the future earning potential of the student.

Average student debt hovers near $20,000, according to federal figures.

Some students borrow more than $100,000 for education. Six-figure debt could make sense for a student pursuing a medical or law degree. Teachers and social workers, on the other hand, cannot expect to make as much in their profession and should think twice about borrowing so much.

"For certain professions where pay is not affected by the school you attended, such as teaching and government work, it doesn't pay to get an expensive degree," said Rod Bugarin, a financial aid adviser at Applywise.com who has worked in financial aid at Brown and Columbia universities.


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"An MBA from Wharton gets you a higher-paying job and the investment may be worth it," Mr. Bugarin said.

Unlike grants and scholarships, student loans must be repaid. Federal bankruptcy law and a U.S. Supreme Court decision have made student debt almost impossible to discharge.

The amount of a borrower's monthly payment is determined by the size of the loan, the interest rate for that loan and the years of repayment.

For example, a borrower with $20,000 in loans repaying them over 10 years at 6.8 percent interest would pay $230 a month. The same $20,000 loan repaid over 10 years at 3.4 percent interest would cost $197 a month.

A $230 monthly loan payment is a much greater burden for a former student with a yearly salary of $20,000 than for someone earning $60,000.

"One of the ways I approach this is to show students a monthly repayment schedule at various borrowing levels and how that relates to a car payment and other expenses," said Helen Nunn, director of financial aid at Susquehanna University in Selinsgrove, Snyder County.

But money should not be the only factor in choosing a major.

"If you are choosing something solely for financial reasons, the student may not have the skill sets to succeed," said Amy Tien-Gordon, vice president and chief student lending officer at ALL Student Loan.

"A student who is a terrific writer might worry they can't make enough money doing that and decide to major in computer science because it's the higher-paying career. The choice may not play well to their strengths and passions."

One commonly used benchmark for evaluating student loan debt is what financial aid officers call the 8 percent rule.

Lenders typically recommend that monthly student-loan payments not exceed 8 percent of the borrower's pre-tax income to ensure they have enough to cover taxes, car payments, rent or mortgage payments and household expenses.

Lynnette Khalfani, a financial adviser and author of "Zero Debt For College Grads," said her general rule of thumb is that students should not borrow more than twice as much as their starting annual income will be. Only in rare cases, such as for law school, medical school or other speciality fields, should the borrowing limit be three times the starting salary.

"Students often make the mistake of overestimating their income and underestimating their expenses when they graduate," Mrs. Khalfani said. "Sometimes they rack up too much debt because they have a distorted view of their personal finances."

Often full of ambition, college students might envision themselves running a hedge fund or being a high-flying investment banker. But they should understand there's a learning and career curve, she said.

"So, you shouldn't take out loans on the assumption that you'll earn as much as the top people in your industry," Mrs. Khalfani said. "While that may happen, it certainly won't be the first few years after graduation, which is when graduates are most pressured by student debt."

A recently enacted federal law called the College Cost Reduction and Access Act of 2007 will ease the burden of debt repayments for federal loan borrowers who choose an "income-based repayment" plan, beginning July 1, 2009. This plan is aimed mainly at those in the subsidized and unsubsidized Stafford loan programs.

Under the income-based repayment, if a borrower's income is no greater than 150 percent of the federal poverty level (now $15,315 for a single-person household), the borrower would not have to make a payment.

If the salary exceeds this baseline, the act would cap monthly payments at 15 percent of income beyond that level. For example, if the individual's salary were $25,000, the $15,315 would be subtracted to get a new baseline of $9,685. The new act would cap the payments at 15 percent of $9,685, or $1,453 a year.

After 25 years of repayment (10 years for eligible public service employees), any remaining balance would be forgiven but treated as taxable income.

While this act will provide relief for many borrowers, it does not apply to private loans. Because of the growing cost of attending college, many students are forced to borrow from both the federal government and private lenders.

Private lenders often charge higher interest rates on student loans.

"In an ideal world, the right amount of debt to graduate with is none," said Dr. Michael Franzblau, president of Tuition Without Tears, a college-funding program that helps families with college-bound children of any age develop a funding plan.

"A college degree is really worth getting at any cost," Dr. Franzblau said. "In today's world, a college degree is now the minimum credential for success. It's really worth the effort and sacrifice, but you have to be smart about it."

The Project on Student Debt, a program of the nonprofit Institute for College Access and Success, based in Berkeley, Calif., was one of the leading advocates of the college cost-reduction law. The idea behind its push for reform was to try to get student loans satisfied in 10 years with affordable payments.

"Otherwise people try to stretch out the loan term to get lower monthly payments, and end up paying a lot more interest," said Lauren Asher, associate director for the project.

Before signing loan documents, Howard Bart Humeston, director of financial aid at Barry University in Miami Shores, Fla., said, students should consider their own personal commitment and ability.

"Honestly evaluate yourself," Mr. Humeston said. "If you want to be a medical doctor and can't pass Biology 101, maybe you should consider another major and different borrowing pattern.

"On the other hand, don't let your fear of student debt prevent you from obtaining your degree," he said. "If you must borrow and can do so responsibly to get that college degree, the dividends from a college degree will pay you back tenfold for the rest of your life."


Tim Grant can be reached at tgrant@post-gazette.com or 412-263-1591.


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