Student Loans — The Expensive But Not Entirely Destructive World

Student loans are a way of life for most college students, as well as for those who are not long out of school. As you undoubtedly know, the reason is that a higher education has become not only outrageously expensive but also too costly for most families to foot the bill out of pocket. The average four-year cost of tuition, room, and board at public universities now tops $25,000 more than double what it cost only 20 years ago. And find yourself a comfortable chair or a soft place to fall if you haven’t heard the latest figures for private institutions nearly $65,000 for the same four years. In fact, that figure is actually somewhat misleading, as one-year costs at prestigious schools such as Ivy League colleges now routinely exceed $30,000. In that sense, if you’re out of school or nearing the end of college, you should count yourself lucky costs are likely only going to continue to increase.

The good news is that the student financial aid market has responded to these stratospheric rises by expanding the availability of student loan programs federal loan programs alone now provide more than $30 billion in aid to students. The bad news is that well, the student financial aid market has responded to these stratospheric rises by expanding the availability of student loan programs. That’s not to say they shouldn’t have, as that would have left untold numbers of students out in the financial cold. But the amount of student debt has skyrocketed as a result. It’s not uncommon for students to pursue and receive the absolute maximum amount of financial aid available to them. And that’s put students and grads into a deeper financial hole over roughly the past 20 years, median student loan debt has exploded from $2,000 to more than $15,000.

But there is an irony to all this. Put simply, there are a whole lot of worse ways to get into debt than owing money for your higher education. Moreover, there are various ways to craft your student loan payback to make it easier and more advantageous to your financial well-being. (I won’t get into the pluses and drawbacks of various types of loans. Unless you’re looking for additional funds or are planning to move onto grad school, that ship has sailed.)

First off, even though the amount of money people owe via student loans has skyrocketed, student loans nonetheless remain a bargain in the otherwise leech-like world of debt. Unlike credit cards, which can carry interest rates as high as 22%, government-funded loan programs such as the Stafford program carry interest rates as low as 7.5% or so. Not only is that a monstrous 14 to 15% difference, but, thanks to federal legislation enacted in 1998, the interest rate on student loans is now tax deductible.

That makes student loans more of a bargain. Here’s an illustration: Say you owe $10,000 at 7.5% with a 10-year payback period. That translates to 10 years of monthly payments of $118.70. In the first year, your total payments would be $1,424, of which roughly $726 is interest. A little number crunching will make a point: Since you’re paying $726 in interest, that means you’re saving about $109 in federal taxes if you’re in the 15% bracket ($726 times .15 = $108.90. More on what brackets mean in the tax chapter just go with that for now). Put another way, your actual out-of-pocket payback for the year is $1,315, since you’re saving $109 on your taxes. Not a bad deal at all.

Naturally, the government being the government, student loan deductibility isn’t without its quirks. For one thing, the deduction applies only to the first 60 months of the loan once you’re past the first five years, no deduction. Moreover, you can’t claim the deduction if your parents still list you as a dependent. And, as it’s written now, the law starts reducing deductibility once you reach a certain income level ($40,000 if you’re single, $60,000 if you’re married and filing a joint tax return). Still, even though there are limitations, a limited amount of deductibility is better than none at all.

In addition to being tax deductible, student loans are generally structured to offer you the lowest monthly payment possible (with the added plus that, unlike credit cards, where monthly “minimums” don’t even make a dent in what you owe, student loan interest rates actually let you make reasonable payments that do make a difference). And, referring back to our discussion about the importance of establishing a credit record, student loans can be an affordable means of doing just that, setting yourself up nicely for home mortgages and other forms of credit where a good credit history carries a lot of pull.