For years, I’ve heard a term that truly baffled me. “Student loans are ‘good’ debt.” I always thought to myself, whose student loans are they talking about? From what I saw, student loans are one of the most difficult debt to clear when you declare bankruptcy. Student loans are taken into account when calculating your debt to income ratio. Median student loans have grown 163.8% in last the 25 years, while corresponding income has grown by a whopping 1.6%. How could this debt ever be considered “good”?
So, I finally decided to take myself out of my echo chamber, and research what characteristics of student loans made it worthy of the label “good debt.” I honestly expected a well thought out thesis with bullet points that would put my Millennial bias to shame. The answer I found was even more baffling than the question I had dared to ask. The primary, and almost sole, reason student loans are considered “good” debt, was because it could potentially lead the borrower to higher income. I literally clicked on other articles, waiting for someone to give me a better reason why the debt that is crippling consumers in their 20s and 30s, is actually a “good” thing. I came up empty. That was literally the only substantial reason…and I use the term “substantial” generously.
Those of us who went to college, only did so in the hope we good potentially earn more in the long run. However, when the price of education is climbing at an exponential rate and income is not meeting it, then this is a recipe for a crippling economy and a student loan bubble, similar to the housing bubble we saw in the early 2000s.
One high school senior told me that she was considering a university, that cost about $50,000/year. She wanted to know if she should work while in school and try to pay down her debt while she was acquiring it. Now if you’re reading this as a college graduate, then you may be having the same reaction I did. By the look on her face, I can tell when I gasped and clutched my invisible pearls, that she knew I did not approve. I was looking at this intelligent, hopeful young lady, and all I wanted to do, was save her from the mistakes that so many of us have made. Working part time or even full time, while being a full-time student, will only put a drop in the bucket to her, soon to be $200,000 priced, undergraduate degree. I told her that instead of putting a drop in the bucket year after year, it would make more sense to shrink the size of the bucket. If she was really set on this school, then I advised her to attend a state college or community college of which her goal university would accept transfer credits, and to do this for the first two years. Then transfer to the more expensive school, for the last two years. That way her degree still has the brand name she wants for networking purposes.
When I wanted to pay off my student loans I had multiple people tell me “Don’t worry about those. Student loans are good debt. You’re never going to pay those off.” And to a point, they were only telling me the best information that they were privy to. The same propaganda that is spread by lenders. The same lenders that take the sum of your student loan payments divided by your income before taxes, to come up with a smoke and mirrors ratio that makes you look as eligible as possible to take their money and return it to them with interest. You might say, “but Jessica why is that a bad thing?” And I’ll say, “well friend, I’m glad you asked.”
Let’s break this down for a moment. When you pay your student loan or any debt payments, are you doing so with after tax or before tax income? If you aren’t self-employed then you’re answer should be after tax income. So, if you’re paying $900/month in debt payments, (student loans, car note, credit cards etc.) and your take home pay is $2,000/month, then how much of your paycheck is going towards your debt? The answer is 45%. Almost half of your take home pay is dedicated to paying debt. At this rate, you may genuinely decide to take a harder look at your finances and figure out how you can decrease your debt.
Now let’s look at this same example, but instead of using your after-tax income (take home pay), let’s look at what you make before taxes. So, you’re paying $900/month in debt payments, and your before tax income is $3,000/month. Now your debt to income ratio is 30%. That looks much better, right? Your debt is only about a third of your income, so you’re doing pretty good. Banks look at you as eligible for more debt, and everything is fine. However, do you ever actually see that $1,000 month? No, that $1,000 isn’t disposable income that helps you get by in your monthly bills and activities. That money is going to taxes and government programs that help keep our society afloat. If it’s money that you never see, then why is it used to calculate your debt to income ratio? It’s used because that number looks like a lot better to lenders, who want to get your rich off of your interest payments. It makes them look responsible, and helps make you feel more comfortable with putting yourself in more debt. This is why it’s up to us, to decide what we can afford, and not let an industry who doesn’t have your best interest in mind, decide for us.
So, to my fellow college graduates and college students, whether your student loans are $5,000 or $100,000, I’m here to tell you that the term “good” debt, is an oxymoron that most of us (literally) cannot afford to believe. Most of us are already well aware that our debt is a problem, and if you’re looking for a way to get started with budgeting and saving, then please visit my piece, Saving and Budgeting: A satisfying hobby or necessary evil?. If you’ve already become a budget master, then take a look at my piece, Snowballing v. The Interest Game; this piece will help you determine which debt to pay off is best for you.
I have no doubt in my mind that we can beat this game of rising student debt, and crawling income, but it will only happen when we all have the correct information, to make the most informed decision for our own financial situations.
That’s all for today, and remember a debt sentence doesn’t have to be a death sentence!
Enjoy the rest of your day!