Students and parents both admit that loans play a major role in financing higher education. In fact, 49% say they anticipate taking or did take on debt (student loans, Federal PLUS loans, or other parent loans) to pay for the cost of college, with a higher proportion of that debt belonging to women and other underrepresented groups.1 It's debt that many people will carry for a lifetime.
Yet there is an important reason for these loans: You're hoping you're paying for an education that will bring recurring benefits in the future—potential job security, increased wages, and career mobility. But how do you calculate the return on your investment (ROI) ahead of time, particularly when costs of education are more complicated than just a dollar amount and whether you take out loans to pay for it? And once you have the debt, how does it fit into a smart, overall financial plan?
To understand the long-term implications of student loan debt, it's important to look at the situation holistically, including the benefits and hidden costs. Here are some questions you can ask yourself to help do the analysis on both the potential financial return on taking out student loans, as well as how they fit into your broader life and financial decisions.
Calculating the ROI on taking out loans
Will there be a financial return on your education investment?
According to a Fidelity study on student loan awareness, the majority of high school students have no idea how much their student loan payment will be or how long they will take to pay off the loan.1 And though it can be hard to project exactly how much you'll make over a lifetime, it's important to estimate what the financial return might be on paying for a degree—specifically, whether the gain in salary is likely to outstrip the cost of the degree, including the monthly student loan payments.
For example, let's give a doctoral degree a hypothetical price tag of $120,000 and a master's degree a price tag of $60,000, which is based on the average for graduate tuition at a private college.2 (This does not include living expenses.) With numbers like those in mind, you can ask yourself:
- Will I be putting myself in a position to be more employable?
- Is my earning power likely to increase by more than $120,000 or $60,000 (plus any accrued interest) over my working years? How long will it take?
- How much is my salary likely to increase because of this degree? 1 year after graduation? 5 years? 10 years?
- If I pay for my degree with student loans, will the increase in my salary be enough to cover the student loan payments? For example, if I have a student loan payment of $1,000 per month, then how much more does my salary need to increase to pay that comfortably? And when is it likely to do so?
- Will this degree have longevity (particularly knowing that women live longer and often retire at a later age)?
- Will I be likely to work in an industry or at a company that will offer student debt repayment assistance? Will I qualify for federal repayment assistance programs (often available to teachers, health care workers, and nonprofit careers)?
- Are there hidden costs to how you pay? The cost of school generally isn't as simple as tuition plus living expenses—it's important to consider where the money is coming from as well as potential lost opportunity costs, particularly if it's for graduate school. For example, many graduate students bypass or leave full-time corporate jobs to take teaching assistant (TA) jobs that include a tuition waiver plus a stipend. The thinking is that this will help reduce the burden of student loan debt. However, many TAs don't consider the fact that they are working for that tuition—just earning it through sweat equity. So if we use the tuition hypothetical of $30,000/year and a TA stipend hypothetical value of $35,000/year, then a total hypothetical TA "salary" is $65,000, with the student “paying” $30,000 of their salary in tuition. Additionally, as a student employee, there will often be a reduction in the value of benefits (like a 401(k)/403(b) match and health care) or your own overall retirement contributions. While taking a TA position will likely help you avoid student loan debt and the interest that comes with it (unless you take some out for living expenses), if you are in a field that doesn't require the teaching experience or networking, it's important to compare the salary, benefits, and career growth of working elsewhere and paying the tuition yourself. (Or if you are lucky, getting education subsidies from your employer.)
Calculating the ROI on paying down loans
Let's say that graduation has come and gone and you have a steady job and a monthly student loan payment that may last for 10 years or more. For the sake of the discussion, let's assume that you're paying the minimum on your student loans, saving for retirement, and have an emergency fund. As you start to have some extra money each month, how do you know if you should try to pay off your loans as quickly as possible and breathe a sigh of relief? Or pay the minimum and consider other options?
- Get organized and informed The first thing to do is to get organized with all of your student loan information, which you can do through the federal government or through our student debt calculator. Write down all of your loans, the lenders, and the interest rates, and whether they are private or federal. This information will likely vary by semester, year, and school, and it impacts certain factors like your eligibility for repayment plans and federal legislation. Finally, make sure you know and understand the type of payment plan you're on (its terms and length of the repayment) as well as other potential options; these should be available on your lender's website.
- Consider the financial return of paying off your loans Once you know the interest rate on your loan(s), you can compare that to how it might perform if invested elsewhere. "If your interest rate is low (like 3%–4%), then you might want to consider investing extra money while you just keep paying the monthly minimum on your student loans—you can give your money the potential to grow beyond the rate of your student loan debt," says Sasha Heathman, CFP®. "But if you have a higher interest rate (like 7%–8%) and/or your student loans are private (and therefore have less flexible repayment options), then you might want to consider putting extra money toward your loans." Look at the rest of your financial situation. Do you have other debt with a higher interest rate? Are you getting a tax deduction for your loans? Is your retirement on track? Do you have more pressing financial goals that you want to save for? Before making a decision, you can use a tool like the student debt calculator or talk to a financial professional. Ultimately, how much to pay off should also be part of a larger financial plan.
- Consider your emotions There is a reason that student loan debt is often called "crushing." It can be stressful, emotional, and feel like it's constantly hanging over your head. If that's something you don't think you can get past, then it might be worth paying it off even if the financial return might not be as high.
How to pay back student debt is both a financial and emotional decision and those are both key factors in your strategy for both taking out loans and paying them off. What's important is making informed decisions on paying for your education and debt and making sure it fits in with your long-term financial goals.