At What Point Should I Worry About My Student Loan Debt?

A student loan debt, similar to credit card debt or any other form of borrowing, should have two main purposes. The first is to enrich your life at an earlier point. The other goal is to build for a better future.

Imagine if there were no such thing as a home mortgage, and that all home buyers had to pay cash up front. America wouldn’t have much of a housing industry. Then imagine if there were no such thing as student loan debt. You would not be able to attend college until you had saved up all the money in advance for tuition, books and housing. There would be a whole lot more students on campus with gray hair and wrinkles.

Therefore, a student loan generally is a positive (albeit costly) personal investment, no matter how much you may dread the thought of those payments.

When are Student Loan Payments Too Much?

You might wish to measure the point at which a student loan’s payback requirements become excessive. This can be calculated by a student-loan to potential-income ratio. Studies show that up to 70 percent of students do not fully consider the impact of student loans on their future finances, and the consequences for their lifestyle choices.

Each individual’s situation is unique. If you plan to marry and have children immediately, for example, then student loan payments will represent a larger burden. (Unless you marry into wealth, of course.)

The most-quoted number for a reasonable debt-to-income ratio is a maximum 36 percent. In other words, for each $1,000 you make per month, your debt should not exceed $360.

Here are a pair of examples of how your student loan may come into play.

1. You’re fresh out of law school. According to the U.S. Department of Labor, the average annual income for a first-year law school grad is $60,000, but there’s a huge variance from one individual to the next. If you are typical and find a $60,000 slot ($5,000 per month), the 36 percent standard allows you $1,800 in monthly debt. Fit your student loan into that.

2. You have achieved a four-year teaching degree and found an opening that pays $30,000 annually, which equals $2,500. Your monthly debt, student loan included, should stay within $900.

Of course, there are an array of student loans. A standard loan allows faster payment, but you probably can arrange for interest-only for up to four years. The longer you take to pay, the higher the expense.

Good Debt Versus Bad Debt

Keep in mind that the 36 percent standard is not etched in stone. Some lenders will measure “good debt” compared with “bad debt.”

A good debt represents an investment that will gain in value such as a home loan, and yes, a student loan. The reason a student loan gains in value is because earnings potential increases with education. According to the College Board, a nonprofit group, people with a four-year bachelor’s degree average about $800,000 more in career income than people limited to high school educations.

A bad debt is not “bad” in that you did something wrong, but debt to buy a car or to take a vacation is not for something that will gain in value. Credit card debt also is considered bad debt. Again, there’s nothing wrong with having credit cards, and a young person should have at least one student credit card to build a credit history. Still, you should understand why your student loan debt is considered good debt, while your credit card debt to visit Florida during spring break is considered bad debt.

The bottom line is that if most of your debt is good debt, then you probably can creep a little beyond 36 percent and still stand on solid ground. College students should keep that factor in mind as they measure their budgets, including student loans, for the early years of their careers.

Michael Thompson