Video: Dissecting Debt
Understanding loans and coping with college costs.
Video by Rowan Forsythe
Want to learn more about student loans? The college debt crisis poses a real threat to the American dream. Part of the issue stems from low levels of financial literacy among Americans, a problem this video seeks to address.
Click here to check out Forsythe’s article on student debt
Transcript
The Biden administration just extended the moratorium on student loan payments for a final time until January. He calls the freeze a critical lifeline. To give you an idea of just how critical, take a look at these numbers. Student loan debt has surged to over $1.6 trillion and only two thirds of that is expected to be paid back.
College is expensive, like really expensive but also, you didn’t need to hear that from me. So let’s break it down and try to up your financial literacy a little bit.
This video will have two parts. First will dissect loans and then I’ll try to arm you with some tips to avoid them entirely.
Like many things in life, the roots of such ludicrously high college costs are pretty complex. Financial illiteracy, student debt, organizational bloat, and rising expectations have come together in a pretty brutal way.
It turns out that financial literacy among Americans has been trending downward since the market crash of 2008. But you’d be right to wonder what else is going on.
Now, the evidence points to something that might seem kind of counterintuitive. Increased access to grants and to loans may be driving up the cost of college. Now, this phenomenon, it seems to be worst at private colleges…which actually makes sense, because in state schools, they typically have restrictions on how much they can raise tuition every year.
With such high costs, debt is unavoidable for many. In some cases, it even makes sense.
To figure out how sensible is, we first need to understand loans a little bit better. Now, I’m no math major, but it’s a numbers time.
The average student debt is about $40,000. But for the sake of this example, let’s assume we have a nice round $10,000 loan.
Interest is essentially the cost of borrowing the money.
Banks show this as a rate. A percent of the total amount. But this number can be deceiving if you don’t know how to interpret it. If you borrow $10,000 at a 4% interest rate, but you pay it back in five years, you actually pay an additional $1,049 on top of your $10,000 loan. Now that’s 10.5% on top of the initial loan amount, not 4%.
But many students, they don’t pay it back in five years. They defer and they don’t make payments during college. This deferment means that the interest is added to the total balance, called your principal, and often monthly.
The principal of our $10,000 loan that we took out our freshman year is nearly $12,000 by the time we graduate. If we defer interest compounds, meaning the interest charged is added to the total and the next time interest is assessed, it’s based on a larger amount. With bigger loan amounts this cycle gets dangerous very quickly.
The term of a loan is pretty simple. This describes how long you have to pay it back. Now, long terms, they sound nice, but taking longer to repay a loan means paying more interest. Paying back our $10,000 loan in ten years instead of five drops the monthly payment from $184 to 101, but more than doubles the total interest to $2149. Now it costs us $12,149 to borrow $10,000…and that’s if we don’t defer.
If this confuses you or hurts your brain, that’s totally understandable. There’s an awesome calculator on student loan hero dot com that brings all of these concepts together under one umbrella.
But now that you see why this gets complicated, let’s delve into some advice.
First, keep your expectations in check. When I spoke to independent college financial aid counselor Paula Bishop, she was adamant about running the numbers on a college well in advance of acceptance or even application.
After all, there’s really no sense in getting excited about a college that you simply can’t afford.
Second, good grades don’t always guarantee good scholarships anymore. A long list of colleges no longer award aid based on merit, meaning your academic performance in high school has little bearing on financial aid.
Next, you should probably avoid basing your college preference solely on perceived fit or prestige. Consider value for your money and the financial feasibility of a school just as heavily if money matters to you.
Bishop also noted that colleges are required to have a net price calculator on their website, but these aren’t always very easy to find. These calculators can help you understand what attending a given school might actually cost given your income and a set of other variables.
It’s also imperative that you don’t think of loans as aid. Loans are just money you have to give back later…plus some extra tacked on. Consider all other sources of payment first.
And lastly, if cost is your primary concern, Bishop explained that cheaper options often exist. You could get a two-year degree first, or take advantage of programs that let you accumulate college credit while still in high school.
So, despite the risks, debt isn’t an inherent death sentence. If you do get stuck taking out a loan, go for one of the lowest possible interest rate and definitely no prepayment penalty. This means you could pay it down quicker if you want to, which saves on interest.
Some government loans even offer no interest accrual if deferring while you’re enrolled, but these are based on need. So if you don’t qualify, do your best to pay the interest well in school, preventing that compounding effect that we discussed earlier. At least your principle is the same as you started with when you graduate.
If you absolutely plan on deferring while in school for whatever reason, wait to take out your loans until later in your college career if you can, because you’ll pay less in total interest.
And remember. Money sounds scary, but you’ve got this