“Can’t I just wait until the government pays for college?” said one of my clients. They were agitated because we were talking about saving for their newborn after they had just finished paying off their own student debts. The idea of saving for college on top of their budgeting, protection planning, retirement savings, and everything else that pulls a person in a hundred directions in life was leaving them exasperated.
Especially with the transition from administration to another, and with one billion dollars of loans being forgiven, people are increasingly wondering if they should save for college. However, there are many reasons both qualitative and quantitative, why it makes more sense to save than to borrow.
The cost of borrowing versus saving
There is a significantly higher cost to borrowing to pay for college versus using savings. To understand the cost of saving versus borrowing we have to make some assumptions. Studies have shown many families do not start saving for college until their child is somewhere around 9 to 11 years old. Let’s assume that they will attend a typical four-year public school, which today costs about $26,820 according to the College Board. Assume college inflation is about 3.7%, that the average investor receives a return of about 6%, and that the cost of borrowing averages 5.3% with a 10-year payback term.
This relatively modest assumption, to pay for college at an in-state public four-year school, would require contributions of $814 per month to fully-fund for total contributions of $117,220. However, were you to rely on borrowing, it would cost $202,907, or 58% more, according to Savingforcollege.com’s Savings vs. Loans calculator. The sooner you start investing for higher education the greater the benefit in terms of reducing the cost of debt. Start when the child is a newborn and that cost of borrow balloons to $162,505 more than saving.
What borrowing looks like
Most people need some form of financial aid to pay for higher education, be it scholarships, grants, student loans, etc. The bulk of college is still paid for by parent income and savings, according to Sallie Mae, accounting for about 44% of funding. Still, 34% of students borrow to help cover their shortfall.
Student loans are not inherently bad, allowing people who might otherwise not be able to get a higher education to pursue better careers. However, the types of loans available and their rates vary dramatically. A federal loan typically ranges between 2.75% to 5.3%, according to Nerdwallet. But private loans can balloon up to 15% depending on the borrower and their circumstances, with some studies suggesting as many as 7% of students resort to credit cards to pay for expenses. As a result, student loans need to be carefully evaluated and managed for repayment by the borrower, something many young adults fresh out of high school may or may not fully understand.
The debt will just be forgiven, right?
According to data from the U.S. Department of Education, of the 227,382 unique borrowers who submitted Public Student Loan Forgiveness applications as of November 2020, oinly 3,776 were processed, or less than 2%. Almost twice that number – still only 4% of total applications – were deemed eligible. Therefore, while it is possible that your loans may be forgiven, it is not a good idea to build loan forgiveness into a higher education funding strategy.
College costs are unlikely to fall
Here lies the problem: Since 1971 the cost of college – including tuition, fees, room and board – has increased by over 17 times at private 4-year schools and nearly 16 times at public 4-year schools. When adjusted for inflation, it’s still 2.7 and 2.5 times more expensive, respectively, according to data from the National Center for Education Statistics, College Board, and FRED (a database maintained by the Federal Reserve Bank of St. Louis).
The average cost of a year of college at a four-year institution for the 2020-21 academic year was over $50,000 at a private and over $22,000 at a public college, according to the College Board. Paying for college outright is nearly impossible for most people without assistance, be it financial aid or debt.
There is also evidence to suggest that government subsidies in the forms of grants, scholarships, preferred loans, and other aid results in increased higher education costs, perpetuating higher inflation. With increased forgiveness programs – which addresses the symptom rather than the cause – tuition inflation is likely to continue to rise. Further, even if tuition were to be eliminated altogether, tuition only accounts for a fraction of college costs once account for fees, room, board, travel, and supplies.
Savings is a guarantee in uncertainty
Every dollar that is saved is a dollar you know you have when you need it. Whether the government increases or decreases higher education funding, whether the interest rate to borrow rises or falls, the money you’ve saved gives you more versatility to make decisions in the future, rather than being beholden to lenders.
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