I keep reading about recent college graduates with such huge student loans that they have to live in their parents’ basement, will never be able to get married or afford a house, and will be in debt their entire life. I wonder how many people who believe this have actually run the numbers.
Take a tough case: Someone who attended a state university, paying full price of $25K per year, and can only find work as a supermarket bagger making $20K a year. The interest rate on his $100K loan is 5%. Here’s my calculation:
Under the PAYE program, the payment the first year is $18 per month. The calculator at studentloans.gov assumes a 5% income increase per year, but let’s assume this bagger only manages 2% a year over 20 years. (Yes, it’s sad that this college graduate has to work as a bagger, but that unpleasant fact has nothing at all to do with his student loans.) Over the 20 years, the monthly payment will rise to $38. Pretty reasonable, but read on.
At the end of 20 years, the amount owed is about $194K, which is forgiven, but it’s all taxable income in that year. As his income has only risen to $29K in 20 years, this is a huge increase in his taxes due. Assuming an effective tax rate on the forgiven amount of 30%, he owes about $58K in taxes in addition to what he normally would pay on his income. He most likely doesn’t have $58K and, even he did, it’s for a house or retirement, not for the IRS.
However, thinking ahead, he has set up a savings plan, and has put money away, assuming at 2% interest per year, and now has $58K in that account, so he just pays the tax bill. To get there, he had to contribute $197 per month (for 20 years). So, his monthly loan costs aren’t $18 going up to $38. They are $215 going up to $235. That’s a lot more, of course, but he does make $20K and rising, so his total loan costs are still only about 9% of his income at the start, going down to 7% in year 20.
So, if this bagger can handle his huge loan, a lot of other people can, too. Most college graduate make more money than baggers, and the average student loan is way less than %100K. Less than $50K, in fact.
The moral of the story? Stop making yourself miserable by listening to no-nothings and do the math.
May 3, 2014
You make some interesting points Marc…. You are definitely right that income based repayment and smart planning can make life with student loans much easier.
However, the example you give is a bit flawed. In undergrad, you cannot borrow 25k from the federal government. Private loans will be needed to borrow 100k for undergrad. If you borrow privately, there is no PAYE program. What is that borrower to do on 20k a year?
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