Monday, February 6, 2012

College Debt or a New Car?

I was talking with a colleague the other day about student loan debt. She shared back "Perhaps we are thinking about student loan debt in the wrong way. We will go into debt $20,000 - $40,000 or more for a new car and not think twice. But we start to panic when a student graduates with $20,000 - $40,000 in debt. The car will last 6-10 years, but your education will last a lifetime."

Now I don’t want you to go into debt to finance your college education if you don’t have to, but I want you to think of your college debt as an investment that will last a lifetime. In Chris Farrell’s article “College Degree Still Worth the Cost Despite the Risk”, he quotes a study at the Booking's Institute that shows the return on investment for a college degree has been about 15% a year for the past 60 years. Not a bad return if I do say so myself, given the stock market has only shown a 6.8% return on investment over the same time period.

However with college, like any investment, there is risk involved. If you are looking at college as just a way to get a higher paycheck, there is a risk that a job may not be waiting for you when you graduate. In fact, your financial return may differ based on your major. So the question is “How much should I borrow to finance my education?”

Think about it this way…what kind of car do you want to drive, and be able to afford 10 year after you graduate? Look at others in your future profession to see what they drive. If they are driving Mercedes, BMW, Audi and Lexus, then they have a relatively high income and therefore they can go into greater student debt based on their future earnings potential. However, if you see professionals in your chosen field driving used cars that just get them from point A to point B, your profession may have a lower earnings potential and you may not be able to repay high students loans easily.

My suggestion is not to borrow any more money than 1-2 times the cost of the car driven by the professionals in your field 10 years after they graduated from college. Yes, I know, many who are 10 years out of college are driving a mini-van, SUV or crossover to haul the kids around, but is it a new loaded car or used-vehicle? This rule of thumb will help you keep your student loans to a reasonable amount based on your future earning potential.

There are many different calculators you can use to see what your earning potential will be, the likelihood of employment, what your take-home pay will be, cost of living, etc., but I like looking at cars. Let me know what you think this 'calculator' to estimate a reasonable amount of student loan debt.