Why student loans are bad

Student loans are a bad idea; avoid them. We perceive that college graduates typically earn more money that non college graduates by almost twice as much. And, that is certainly possible.

In addition to more money, we’re told that college graduates tend to have a better lifestyle than non-grads. You can probably guess why—more money, better life. So, if education is the key to more money and a better lifestyle, why is this popular means of securing an education a bad idea?
In this post, I’ll mostly be addressing federal student loans, but much what I’ll present is applicable to private sector loans, also. I think this information will give you reason to seek alternatives to using student loans to finance your education.

No guarantee

I’ve just indicated that our conception of a college education holds that it’s the threshold to a good life. That given, it’s understandable that many, many people want a degree. Unfortunately, reality doesn’t quite mirror the conception. If it were entirely true, there should be little problem with graduates repaying the debt they take on to get that higher education. But … Every year 1 million people default on their student loans. Most default because they can’t afford to make payments against their loans. If a degree is supposed to lead to success, why is this happening?

No one wants to admit it, but there are a lot of college grands who find themselves it unemployed or underemployed. No one wants to make that fact widely known. That includes loan agents, colleges and universities, even the government (and the government is a major sponsor of student loans). A college education doesn’t guarantee prosperity.

With the number of defaults on student loans, we need to ask if going into debt to get an education is a good idea.

The problem

Instead of working their way through school and applying for grants and scholarships, students often borrow what they need to attend college. That’s a large part of the indebtedness problem. To exacerbate the problem, many students tend to borrow more money than they need to cover school and basic living expenses. In fact, this is often encouraged under the tenet that students need a “whole college” experience. It’s not unusual for the extra money to be used to fund a sort of bacchanal (over indulgent) lifestyle. (I’ll tell you a nasty little secret about this: They get used to that lifestyle and are disinclined to see a need to cut back or downsize after graduation.)

Another part of the problem is that students are led to assume that, after graduation, they’ll be in the position to easily repay the money they’ve borrowed. Given that many college students have access to fairly easy money in the form of student loans and are exposed to opportunities for high living, they make poor choices about borrowing money and are unprepared to accept the cost of repayment. Instead of paying off their loans, they go deeper in debt trying to maintain a life that is really an illusion; delusion may be a better word.

Debt is Debt

Loans, indebtedness, and financial responsibilities all equal the same thing: You owe money. Owing money is never good. It’s been said “money buy’s choices.” It certainly does…until it’s obligated. If half your paycheck must be committed to paying loans, debt, and covering financial responsibilities, you can’t take advantage of the same choices that would be available to you if your whole paycheck were unencumbered. Being in debt limits your choices.

Good debt or bad debt

We’ve all heard that it’s OK, even good, to go into debt to purchase items that appreciate in value or provide an income. There may be some credit in that idea; it comes with a need to be cautious. In contrast, debt used to buy items that depreciate in value (like a new car) or a night out on the town (which is only good for memories) is bad debt.

An education may be good, but it’s expensive. You can’t sell it back and you can’t borrow against it. In that respect, it can’t be considered a real asset. What it gives you is potential; all you can do is hope for a decent job. That makes the money you borrow to get your education—student loans—qualify as bad debt.

Interest rates may be high

The interest rate on government sponsored student loans (federal student loans) is based on the yield of the 10-year treasury note of the year you take out your loan. This means that the interest rate on any federal student loan is based on the interest the U.S government pays against the money it borrows (in this case represented by the 10-year treasury note). The rate is recalculated every year but is permanent for the life of all federal student loans taken out in each particular year. In other words, if the interest rate goes down in any year after you obtain your loan, you can’t refinance through the government to get a better rate.

The interest rate on private loans is based on your credit history or that of a cosigner. This means you’ll probably pay a high interest rate, if for no other reason than there is no collateral. Collateral means that if you default on (don’t pay off) the loan, the lender has the right to something of yours that is deemed of nearly equal value to the amount you borrowed. The collateral makes it a secured loan; lenders will get something in return for allowing you to use their money—either repayment and interest or something of yours. An unsecured loan, one made without a guarantee of the lender getting any return—is considered risky (and reasonably so). Although most people a least start making repayment, if career plans go unrealized or foolish lifestyle choices are made, financial problems may arise and payments abandoned. Lenders count on the high interest rate paid by people who don’t default to help mitigate their loss.

Delinquency and default

You’re delinquent when your loan payments are late. If you are late at all, it’s likely you’ll have penalties to pay and your interest rate may increase. If you are more than 30 days late on a payment, the credit bureau may be informed. That could mean a downward movement in your credit score. (There is no hard-fast rule as to how soon you will be reported after you are 30 days delinquent, but lending institutions are allowed to do so as soon as that 30-day mark passes—and they usually do.)

You are in default when you make no payments or cease making payments. After about 9 consecutive months of missing your scheduled loan payments you’ll be considered to be in default on your federal student loan. Of course, you’ll have been delinquent long before that. (Loan companies in the private sector have their own standards, but they tend to be less generous.)

There are additional consequences to being in default on your federal student loan than there are to being delinquent. Among them, the whole amount of the loan is due immediately. You’ll be responsible for any collection and legal fees associated with resolving the problem. Tax refunds can be seized, wages garnished, liens placed against your property…the list goes on. (Again, if your loan is from the private sector, similar actions can be taken.)

Once you are in default, you have limited options. Instead of just letting it happen, get in contact with the entity who holds your loan, especially if it’s government sponsored. There may be some recourse for mitigation.

Your loan agreement may have a clause about repaying the unpaid balance in full. (Uh, yeah. If you’re in financial trouble, that’s unlikely.) Another may cover a loan rehabilitation agreement, and a third could be a loan consolidation++. That third option might mean securing a private loan to pay off the federal student loan.

Any of the above options are easier to implement if initiated before you actually go into default. None of them will get you out of your obligation to repay the debt, but the impact on your credit rating (and life) could be minimized. Hopefully, you kept your copies of the paperwork for the loan. (The lender will have a copy, but having your own and an understanding of what is available to you increases your ability to negotiate the outcome.)

Bankruptcy

As I just said, repayment of student loans is very difficult to avoid. If you can’t make your scheduled payments, your credit rating will be damaged. You’ll face the challenges and penalties as anyone else who defaults on a loan. If you can’t come to a workable agreement with the lender, you could be turned over to collections and sued. Your wages can be garnished and liens can be placed on your property.

Usually, even bankruptcy won’t help. You would have to prove paying the loan would cause undue hardship for you or your dependents. In the case of student loans, undue hardship isn’t defined and that makes it hard to prove.

Student loans can hurt your debt-to-income ratio

Your debt-to-income ratio is a comparison of how in debt you are to how much you earn; it’s is the amount of money you owe compared to your earnings. Your debt-to-income ratio is a major factor when it comes time to buy a house. If your debt-to-income ratio is 43% or higher, most mortgage companies won’t lend to you. It can affect other aspects of your life, like purchasing an automobile. It may also affect how much you pay for car insurance and even the rate you’re charged for your utilities.

Derailed goals

Student loans can be problematic even when you consistently make your scheduled payments. The life of the loans are usually at least ten years and can be longer. What would you expect to happen in your first ten years after graduation? Common answers are: get a job, start saving for retirement, get married, buy a car, and buy a house. (Many people have at least some of these goals, maybe not all, and not necessarily in this order.)

If you’re carrying a lot of debt, much of your income may be dedicated to paying it off and almost all of the above require money. Yes, you’ll probably secure a job, but even with a college education, the pay for entry level jobs doesn’t allow for much excess, and some of your money will go to pay off those student loans. It makes successfully achieving those goals difficult.

Too often, people think taking on more debt could be the solution. (Just to let you know, I don’t recommend that doing that.) Quite a few lending institutions may be opposed to that plan. These companies require that you at least show them you will be able to make your payments. If your debt-to-income ratio isn’t sufficient (according to industry standards) to allow for more debt repayment, you won’t get a loan. There are other loan companies that operate outside the standards. You may be able to secure money from them. Unfortunately, if you default, you’ll find you’ve hocked your future.

Loans leverage your future

If you borrow too much money in student loans or otherwise, your debt-to-income ratio will be too high. That can affect the type of employment you’ll be offered. When I was in the Navy, too much debt would keep a person out of the Navy and acquiring too much debt (being unable to pay your bills) would get you put out. There are other employers that will not hire your if you have too much debt. They think excessive debt is a signal of poor decision making ability, that you could be a risk rather than an asset if they hired you.

Defaulting on your loans will cost you. As I’ve already said there will be penalties and higher interest rates. Your credit rating will be damaged and it may take years to rebuild it.

In most cases, bankruptcy isn’t an option for federal student loans. (Should you attempt bankruptcy, be sure you consult an attorney that has bankruptcy expertise in dealing with student loans.) If you intend to file bankruptcy for other debt, you need to know that it’s not usual for the information to stay on your credit record for 10 years and will influence your financial options at least that long.

Who’s responsible

If you think you can take out a student loan for your child and the child will be responsible for repaying the loan, think again. You could have that arrangement with your child. Ultimately, however, you took out the loan. That makes it your debt.

Cosigners beware

Students sometimes secure education loans themselves. There may be conditions that go with it. A common one is a required cosigner. A cosigner agrees (in writing) to guarantee payment if the person who signs for the loan—the student—doesn’t repay it. That makes the cosigner liable for the loan. If you cosign, you’re doing your student a favor. Don’t do it if you can’t afford the payments. If you do cosign, be sure the student understands financial responsibility and is committed to repaying.

What to do instead

Apply for scholarships and grants

Although there is some overlap, there’s a basic difference between a grant and a scholarship. Grants tend to be awarded on the basis of financial need. Scholarships are based more on merit—grade point averages and/or some special trait, including interests and abilities. Familial descent, exceptional tallness, volunteer work, expertise in duck calling, comprehensive knowledge about the U.S. Postal Service are a sampling. Check the internet for unusual scholarships; you’ll find quite a few.

Applying for grants and scholarships takes time, but can be well worth the work. Essentially, it’s free money. Start early. Most have application time-frames and if you investigate far enough ahead you might be able to acquire qualifications for more than you’d think. Apply for as many grants and scholarships as you can.

Accept gifts

Maybe even before you start high school, you know you’re on a college track. You put work into the academic aspect of preparing for it. Why not give the financial side some effort too? Birthdays, Christmases, and any other time family and friends want to give you gifts, if they inquire about you what you’d like, ask them to help you graduate from college as near debt free as possible. Set up a special account they can make deposits to. While I’m talking about gifts, look at crowdfunding as a possible way to receive more help. I’ve found several students asking for money to enable them to graduate debt free.

Before approaching people or organizations to help you, get an idea of how much your costs will be. People tend to respond to concrete information. It’s important to have your facts straight, and to spend any money you receive the way you said you would.
Work while you study

That’s right, get a job. When I was in college student loans were certainly available, and many people chose to use them. But, many students also chose to not use them; they knew they would have to pay them back. (Who wants to be buried in debt?) Most people I knew worked small part time jobs to offset the cost of going to school and reduce accumulating more debt than necessary.

Test out of classes

Tuition and books are expensive. Most colleges provide a way to test out of certain classes and still get credit for them. You may be required to pay to take the test, but it will cost less than the class would. If you successfully test out of a class, you don’t need to pay tuition or purchase books for that class. Money you don’t need to spend equals debt you don’t need to accrue.

Start at a community college

Community colleges (sometimes referred to as junior colleges) are 2-year institutions that offer basic classes at Freshman and Sophomore levels. Some also have certain specialty 3-year specialty courses for professions that need some expertise, but not a 4-year degree (like surveying). Tuition at community colleges tends to be considerably lower than at a university.

Just as at a university or 4-year college, you can test out of the classes at a community college. You’ll want to go to an accredited school. That will allow you to take classes that will transfer to an institution where you can finish your degree.

In addition to reducing the costs of education by attending a community college, many students choose to live at home for those first 2 years. That can save you a lot of money too. The idea of taking first and second year classes at a community college, then finishing at a 4-year college or university is gaining popularity.

Conclusion

Given that debt is bad, student loans are bad. If you use student loans to finance your education, you’ll begin your career with a mountain of debt to pay off. Actually, that mountain of debt is there and you will be required to pay it even if your career does not take off immediately. Federal student loans are particularly onerous in that some of the options to alleviate the burden that are available for loans obtained in the private sector are not applicable to government sponsored loans.

If you become delinquent or default on any loan there are consequences—penalty payments, increased interest and disadvantageous credit ratings among them. These consequences can delay or keep you from achieving some life goals. If you do make your scheduled payments, the outlay of funds can do the same.

There are alternatives to going into debt to finance your education (or at least into as much debt). Consider preparing for the financial aspect of your education just as important as your studies. Start saving early, ask others to invest in you, consider going to a community college and living at home a couple of years before heading to a university. Once at a college seriously consider keeping down expenses not directly related to obtaining your degree. Keeping your lifestyle simple and conservative can leave you with more money to put towards your classes and supplies. Minimizing extraneous expenses while you are in school can help keep you from finding out after