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Week of 7.10.09

College: How Much to Spend?

Manisha Thakor
Learn more about Manisha and ask her your questions
The idea behind higher education from a purely financial point of view is this: In return for spending some money now, you—or your child—will receive an education that allows you to earn significantly more than you would have without that education. Included in this investment should be enough to comfortably pay back any student loans taken to finance college.

Today, despite America's economic troubles, it remains true that earnings are significantly more for those with a university degree. Data from the U.S. Census Bureau shows that, on average, those with college or graduate degrees earn significantly more than those without. But when we look at the ability to comfortably pay back student loans, things get muddier. That's because over recent years the cost of higher education (pdf) has grown much more rapidly than wages.

"Over recent years the cost of higher education has grown much more rapidly than wages have."
Student loan debt—like death and taxes—may follow you to the bitter end. That's one of the reasons why the question of how much to spend on higher education should not be taken lightly. It requires the same degree of unemotional pragmatism that a business uses to decide upon its future capital expenditures. So what's the answer?

In an ideal world, the total amount of student loans should not exceed a person's expected average income over their first ten years out of school. For example, if your child's academic interests will likely result in an average annual income of $50,000, then $50,000 is the maximum amount of loans to consider.

"The total amount of student loans should not exceed a person's expected average income over their first ten years out of school."
What's the rationale behind this? It has to do with paying those loans back. If a young person has to spend more than ten years of spending 10% of their gross income on student loans, it will crimp their ability to save for other life objectives such as a home or a car down payment. Where did that rule of thumb come from? Well, if your gross income is 100% of what you have to spend and Uncle Sam takes (on average) 25% of that, you are left with 75% for all of the rest of your living expenses. In an ideal world, you'd be saving 15% of your gross income for the future. That leaves you with 60% to spend on your current life. If more than 10% of your income is going to student loan repayment, you are now left with less than 50% for everything else.

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These are not hard and fast rules, merely guidelines. The education of your choice—or your child's—may make you so exquisitely happy that you don't mind paying those loans off for 15 or 20 years. The key is to be informed about what you're signing up for. As an investment, a $150,000 graduate education in music to become a grade school music teacher earning $35,000 is probably not music to anyone's ears. It can also be a recipe for massive debt and extreme financial hardship. This doesn't mean it shouldn't be done, but it does mean the financial consequences of this choice should be understood beforehand.

The main point is this: It is vital to look at the cost of higher education with the same critical eye that we Americans are currently examining all of our financial investments. Only then can you decide on how best to invest in your education.


Note: The answers provided by Manisha Thakor represent solely her opinion and do not represent the opinion of NOW or its producers, who bear no responsibility for them. These answers do not necessarily reflect knowledge on Thakor's part of all factors relevant either to the circumstances of the questioner, or to circumstances experienced by others in their own situations. You therefore should consult with, and solely rely on, your own professional advisors before making any material financial or legal decision rather than on the answers provided here.
 
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