Student Debt and Personal Financial Planning for College

Introduction

This paper examines student debt, concentrating in particular on the types of debt incurred by students, the overall level of student debt, and how students can plan and manage their debt.

The amount of student debt has climbed in recent years to historically high levels (Block, 2006). Average student debt for undergraduate bachelor of arts degree recipients, by type of college for the 2003–04 academic year, was as follows: $24,200 at private for-profit institutions, $16,000 at private nonprofit institutions, and $10,600 at public institutions (CollegeBoard's 2005 Trends in Student Aid).

Student debt is a combination of commercial and public debt. This paper addresses each type in turn: publicly financed student debt related to tuition, privately financed student debt related to studies, and personal debt — primarily credit cards. Each category has a specific repayment structure and a different repayment period.

Supporting College Tuition

A college education is generally a good investment. Those who hold a high school diploma can expect to earn $1.2 million over their lifetimes, while those with a bachelor's degree will earn $2.1 million (Day, 2002). This difference of $900,000 in lifetime earnings can be compared to the average tuition, room, and board cost of a four-year education, which ranges from $50,000 to $250,000. While on a present-value basis $900,000 would not appear to be a strong return on a $250,000 investment, those who pay higher amounts for a private education at an elite institution are generally more likely to pursue master's or PhD-level studies — which result in higher income — and tend to earn more even if they do not proceed past the bachelor's degree level.

For these reasons, it makes sense to borrow against future earnings. Pell Grants and student loans allow students to borrow with little or no collateral and to repay over the next 10–15 years at a low interest rate. Students should ask themselves whether they plan to pursue a career in which they will be able to repay those loans. If, for example, a student wants to become a teacher — particularly in high-demand areas such as math and science — many states and municipalities offer student loan forgiveness programs (Rimmer, 2006). If a student plans to later attend graduate school, the same question must be revisited: although medical and law school can be very expensive, loan programs can cover the bulk of expenses and can generally be repaid out of future earnings.

A student should regard his or her education as an asset, much like a home. Will that asset appreciate sufficiently to cover the cost of the loan? The student should project future earnings, paying particular attention to when income will begin. The U.S. Bureau of Labor Statistics provides a number of such projections, broken down by career type and by gender and race (Hecker, 1998).

Personal Debt

Students are constantly bombarded by offers for "free" credit cards. The repayment terms attached to those cards, however, are generally exorbitant. Since most students have high expenses and relatively low income, it generally does not make financial sense to accumulate credit card debt during the college years.

Students are nevertheless taking on credit card debt they cannot afford. A survey conducted in 1998 found that two-thirds of undergraduate college students carried a balance on at least one credit card, and that one in four held five or more credit cards (Holub, 2004). Average credit card debt for students was $2,200 per student (Lazarony, 1998).¹ This means that a student maintaining such a debt level must make a minimum payment of approximately $100 per month and pay an interest rate of roughly 20 percent per annum — nearly $500 in annual interest charges alone.

It is tempting for a new college student to take advantage of the many credit card offers that appear upon arrival on campus. For many students, this is their first experience living independently. They may observe their parents carrying high levels of debt and may lack the financial sophistication or self-discipline to understand how credit card use affects their credit rating and repayment capacity. Although some college freshmen have had prior experience with credit cards, not all are familiar with common credit card pitfalls, as illustrated by this comment from a college student:

"As a younger teen, I actually received a credit card and didn't know my spending limit and that kind of thing, so I maxed out the credit card and was penalized for it, and that's why I don't have one now" (Lucas, 2007).

The best advice for freshmen considering a credit card application is simply to wait. The temptation to obtain a card and begin spending is significant, and new students have less experience managing credit and independent living. Many financial advisors recommend waiting until at least sophomore year, or until the student is closer to earning a regular income (Lucas, 2007).

Conclusion

Few students are fully prepared for the relatively easy availability of credit after they enter college. In many cases, they may have had no prior experience managing their own credit. Many are encountering their first period of significant debt accumulation — whether through government loans or private lending institutions. A student should regard him- or herself as an asset, make reasonable financial assumptions about future earnings, and assess his or her current debt capacity with care.

Although credit card offers are tempting, it is generally best for students to set those offers aside and attempt to live within their own resources during college. Avoiding short-term debt that cannot be covered through current income will place the student in a far stronger financial position upon graduation.