Is Borrowing Money To Pay For College A Bad Idea?

What I keep meaning to write about, is more about the broader conception of "liberal arts" that I'm trying to put together. However, an interesting side-discussion about college debt sprang up in the comments of a post over at Jennifer Fitz's blog, and when it comes to dashing off a quick post during a break, it's always easier for me to write about money than about more thoughtful concepts.

There are a lot of articles going around at the moment about a "college debt bubble". According to the most recent annual report by the Project on Student Debt, two thirds of people graduating college in 2010 graduated with student debt, with the average amount of debt for student graduating with loans hitting an all time high of $25k.

Some of the particularly high debt and low debt colleges are somewhat surprising. The very elite and expensive Williams College and Princeton University both show up on the list of lowest-debt colleges. State by state and college by college data can be accessed here. It's worth fooling around with a bit. For instance, I found that for 2008-09 graduates, the following three colleges had the following percentages of debt and average amount of debt:

No, that's not just because rich people go to Harvard, though that probably helps a bit. Harvard has by far the highest tuition ($54k this year with room and board, compared to $30k at Steubenville and 20k for in-state students at OSU), but it is also far more successful in providing its students with non-loan financial aid-- in part because it uses that high tuition as a way of extracting more money from wealthy students and using it to subsidize students of more modest means.  A college without Harvard's massive endowment and without its strong attraction to very rich students would not be able to pull this off. Clearly, it sometimes really does pay to go to an elite college, even if the tuition sticker price is higher.

But I digress. (Put a fun data tool in front of me and see what happens?)

Suffice it to say: A lot of people borrow a lot of money to go to college. More and more people are doing so, and they're borrowing more and more. Should we advise people not to do this?

On the one hand, it is clearly possible to get yourself into a lot of trouble with college debt. Some people, either by "paying" for their entire tuition with loans or by drawing college out to more than four years and/or going on to grad school (and using mostly loans to pay for it) manage to rack up some pretty impressive bills. Stores about the "college bubble" are usually accompanied by an "I am the 99%" style picture of someone saying he or she has $100,000+ in college debt. Well, if you have a $100,000 loan for a 15 year term (common for college loans) at 7% interest (common for non-subsidized college loans), your monthly payment for the next 15 years will be $899 dollars. In most cities in the US, that's more than you'd pay for housing. If you're a new college graduate trying to pay for that $899 bill and for housing, transportation, bills, food, clothes, etc. (and potentially for loan payments for a spouse as well) you can see how the numbers could well just not add up.

So if you're contemplating taking out debt to pay for college, you need to think about what the payments are going to add up to. Look at the financial offer letter you get from your college, see how much borrowing they expect you to do in your first year, then multiply that by 5 (to hedge and deal with the possibility they may change your grant to loan ratio in later years) and run that number through a loan calculator. For the last 11 years, MrsDarwin and I have been paying ~$250/mo towards paying off her college loans (I had enough scholarships and savings I didn't take any out). That seemed like more back when we were newlyweds with a monthly take home income around $2,000/mo and Los Angeles rent of $1,000 per month. However, I certainly would not consider it too high a price to pay for the education we got. Even though MrsDarwin hasn't worked for the last 10 years, I would not remotely consider that money a bad investment. That said, if your situation is such that you're looking at very high monthly loan payments to service your student debt, you need to do some serious thinking. Average first year income for recent college graduates ranges from around $30k for "liberal arts" majors up to $50k for some kinds of engineers and business related majors. You need to also hedge that with some assumptions about risk: the economy is more uncertain than ever, and although that could change, it's worth considering the risk that you'd end up for a while like the nearly 10% of recent graduates who are unemployed. (Student loan payments can be pushed out during unemployment in many cases, but additional interest and fees can rack up in the meantime.)

Another important thing to consider in this regard is why you're going to college. If, like me and MrsDarwin, you're going to college for the purpose of deepening and broadening your education, you need to think about how much getting that education is worth to you.

If you are going in order to get some kind of professional degree or certification, it becomes a much more straightforward and monetary task: You need to consider what your chances are of successfully utilizing the degree or certification you're pursuing, look at how much those who do successfully get a job based on such a degree make compared to your other options, and thus decide whether this professional education represents a good return on investment. Since you're not pursing a professional degree or certification simply for the joy of learning or for the experience, it makes sense to be very hard nosed about the analysis involved and determine whether the risks and costs involved are worth it. (In regards to professional degrees and certifications, make sure you consider the reputation and advantages of the particular college you're considering as well as the degree in general. There is a huge difference between the prospects of someone graduating from Harvard Law and the Whittier College law school. Also, be incredibly suspicious of for-profit and/or online colleges in this regard.)

But wait a minute. I keep addressing this question as if it's merely a matter of how much debt it's "okay" to take on in order to pay for college. Should people who are only 18-22 years old be racking up tens of thousands of dollars in debt at all when they don't know how much they're going to make in life? After all, they could be walking down the aisle from getting their diplomas, have a seizure, and remain paralyzed and brain damaged for the rest of their lives, unable to hold a job. What would you do with your "moderate" $25k in student loans then? Why not just go work for three to five years, save up, and then go to college if you still feel the need?

I think this level of debt aversion is probably mis-placed for several reasons.

First, one of the things that debt is good for is "income smoothing" over the course of your life. Most people earn very little when they're young and earn increasing amounts through their lives, peaking in their '50s. Given this, it makes sense to borrow money for large expenses that are best incurred when you're younger (going to college, buying a first house, etc.) You will earn the money to pay for them, you just haven't earned the money yet. If you can purchase such items much sooner by taking out a non-ruinous amount of debt, that's often the economically more efficient thing to do.

Second, you're likely to make the least money when you're young and inexperienced. Thus, giving over the years when you're 18-22 to education doesn't mean forgoing much income. You wouldn't make much then anyway. However, if you wait till you're 25 and then think about going to college, you'd be giving up much more valuable years of your career arc. Add to this that later in life you may have responsibilities that make it difficult for you to devote yourself fully to study (I certainly couldn't do that now, married with five kids) and that many people have more mental energy and flexibility of the sort required by intensive education when they're younger anyway.

Third, saving up for a big ticket item often takes much longer than buying it with a loan and then paying the loan off. When you're saving, there's always the option of skipping your "savings payment" one month, or using your savings for some emergency (or just other purpose) that comes along. Thus, even though when you take out a loan you pay interest while when you save you earn interest, it will generally take you much longer to save up $25,000 than it would for you to pay off a $25,000 loan.

Yes, there are potential pitfalls out there to borrowing money to help pay for college, but within a reasonable range it is an eminently reasonable thing to do in our modern economy. If your purpose in going to college is, as I argue it should be if you're going to go to college, to obtain an education that you believe is going to benefit you for the rest of your life, agreeing to pay for it in installments up until your mid thirties is not an unreasonable thing to do, so long as you believe it's reasonable to think you can handle those payments. Looking back from the vantage point of my mid-thirties, I certainly consider myself to still be benefiting from my and my wife's college educations. I have not problem with continuing to pay for them.

In Which I Become Very Rich

I was standing around with "the guys" after a dinner here tonight, and a friend was talking about how Apple stock is now trading over $400 a share.

"Did you know they nearly went out of business back in the mid '90s?" someone asked. "Can you imagine if you'd bought stock back then?"

Ah, but you see, I did. Have I mentioned that I'm rich?

Well, that's because I'm not. But here's my "brush with riches" story.

Back in the summer of 1996 I was the right mixture of arty and nerdy to be an Apple fan back when Macs were beige boxes and Steve Jobs was still in exile. I bought an Apple PowerBook (one of the early color ones) and an Apple printer to take to college the next year. I was in the throes of writing a novel, and I'd worn out the keyboard of my dad's old laptop. Somehow, I'd taken to reading the financial section of the newspaper (okay, so I was an odd kid) and I was shocked to discover that Apple stock was selling in the $4 range, so I raided my college savings and invested $2,000 in Apple stock for $4.85 a share.

Apple did well over the next few years. By the fall of 1999 that $2000 has become $9000, which to my eyes was a lot of money. I'd read that it was important to diversify your investments, so I sold two thirds of the Apple stock for $22 per share. I invested a third in other stocks and took a third out in cash to buy a 1989 Honda Accord so I could work off campus and make more than minimum wage.

In 2002 we were a young married couple, short on money, and Apple wasn't doing so well, despite the fact that trendy teenagers were now going around with white earbuds. The stock was selling for around $10 per share. So I sold all the stock that was left (Apple and otherwise), paid off our credit card bill, and put a bit under 2000 into a Roth IRA. I bought a couple different stocks in the IRA, including 60 shares of Apple stock. Being hard up (and having access to a 401k at work where I could put money away without paying taxes on it first) I never put any more money in the IRA, and so never bought any more.

At the time, that was about $600. Now it's $24,000. (Which I hadn't realized till my friend told me Apple was trading so high. Since I haven't touched the account in eight years and I can't access it till I'm in my 60s, I make a point of never looking at it in order to avoid worry.)

Still. I couldn't help thinking that if I'd never taken any money out of that original account, I would have, if I'm doing the math right $166,497. (And the cost of that 1989 Accord, in opportunity cost, was $56,000.) Which maybe isn't rich, but it's a heck of a lot of money from where I sit.

Which I guess just does to underscore that you have to have money to make money. Through the brand loyalty of a 18-year-old -- certainly not any true financial perspicacity -- I stumbled on a 83x return over 15 years. But you still don't make millions unless you have a fair amount of money to invest.

Forcing Mechanisms: Cash Budgeting

The Darwin household has now been operating for about four months on a modified version of Dave Ramsey's budgeting ideas. This means that we've basically stopped using the credit cards (though contrary to Ramsey's advice, we still carry them for emergencies and have a few recurring bills that post to them each month) and even the debit card, and instead pull out an allotment of cash for all in-person purchases each pay cycle.

This at first felt very alien to us, as both of us have, by habit, not been people who carry much of any cash around. Going down to the bank and withdrawing anywhere from 500 to 900 dollars in cash still feels strange, this compounded by the way that the teller's eyebrows go up as she says, "And what kind of bills do you want for that?"

However, of all the Ramsey suggestions, cash budgeting is the one that we've found the most useful and followed most closely. The reason is that it makes keeping to one's budget very, very easy.

As inveterate planners, we are both very fond of budgets. There's a precise pleasure to planning out exactly how things will work for the next several months and seeing the rows and columns neatly add up. The problem is that while we both enjoy planning a great deal, we are both very bad at actually following a routine consistently. Self denial we can handle, and so a couple weeks of very low food spending and no "extras" is easily accomplished. But saving receipts and totaling them up every night is something we have never been able to do consistently. And so the analysis as to how closely we were meeting our budget would fall by the wayside, and after the initial burst of frugality, things would fall apart and we'd go back to that magical equilibrium in which outflows equal inflows and extra loan payments and extra savings don't seem to be happening.

Pulling out an allotment of cash based on planned in-person spending makes budgeting pretty much automatic. If you know that you have $500 to make all in-person purchases during a two week period, you don't need to to keep receipts and do nightly tallying-up in order to see how you're doing. Every time you open your wallet, it's clear how much money remains. Indeed, though we have a spreadsheet where we keep track of in-week spending by category to compare with our budget, we've stopped using the "envelope method" of splitting cash up into allotments for each spending category (thus avoiding the discussions of "Are diapers grocery or household if I buy them at the supermarket at the same time as groceries? Are gardening supplies household, home maintenance, entertainment or personal spending?) and started simply using a single slush fund of cash for each pay cycle which we split between the two of us based on who is doing the major weekly shopping runs. We have spending broken out by category in the budget, in order to arrive at the total amount of cash to withdraw, so we have a basic idea of what we can and can't afford in the current paycycle. But actual budgeting within the paycycle does itself by means of the simple "How much do I have left?" calculation.

Thus, while I don't share Ramsey's horror of credit cards themselves, cash budgeting is probably one of the tools that we will continue to use most consistently from here on out. It acts as a forcing mechanism in regards to budgeting. You no longer really have to put any thought or effort into staying in budget, so long as you don't spend more cash than you took out.

Credit Cards and Market Intelligence

The other day I ran into a link to this NY Times article about credit card companies using information about what people buy to attempt to "profile" customers and see who is likely to default on their consumer debt. I'm not sure if I'm particularly cynical or hard hearted, but I don't find myself as shocked as I gather the author is that credit card companies would do this. Credit card debt is unsecured, and so if someone declares bankruptcy, they often get almost nothing. Because of this, credit card companies are often willing to write off 50% or more of what someone owes in order to keep them from declaring bankruptcy.

Clearly, at that point, they face a huge amount of risk. They make up for that with interests rates much higher than you'd pay on secured debt, but even so I find it hard to blame them for wanting to gather what information they can based on customer activity to decide whether to extend someone more credit, or rein them in.

No More Debt, in theory and in practice

A few weeks ago Darwin's favorite economics podcast, EconTalk, featured Megan McArdle, a libertarian blogger he reads frequently. The topic was Debt and Self-Restraint, and a good portion of the podcast was devoted to McArdle discussing how she'd worked out of debt by establishing a budget, using cash instead of credit cards, and paying off loans as fast as possible. Of course these are pretty basic principles, McArdle allowed, but "pretty basic" does not translate into "universally followed". Even we, who consider ourselves basically financially savvy, found ourselves writhing guiltily as we pondered our lack of firm budget and our reliance on credit cards as our normal financial tool.

McArdle had been inspired to financial self-control while researching Dave Ramsey for an article she wrote for The Atlantic. We had never heard of Dave Ramsey, but it seems he's a financial guru with a radio following of 3 million listeners. So we bought Ramsey's latest book The Total Money Makeover (on Amazon, using a credit card), and read and discussed it over the holidays. In the book Ramsey says that people tell him that his book was the first one they'd read in ten years, and (to be honest) it does read rather at that level, but his process in a nutshell is:

1. Quit using credit cards
2. Make a budget in which every last dollar of income is accounted for.
3. Save $1000 as an emergency fund.
4. Start paying down debt (except your mortgage) with every extra dollar, starting with your smallest debt. Pay the minimum on all other debts.
5. As you pay off a debt, roll that money into paying off your next smallest debt.
6. Once your debt is paid, save a larger emergency cushion, perhaps equal to three months income.
7. Pay off your mortgage at an accelerated rate.
8. Invest, Give, and Have Some Fun with your money.

Our debt, we thought, lay in four categories: Student Loans, Mortgage, The Van, and The Dryer. In an act of self-delusion, perhaps, we never considered ourselves in credit card debt because we pay off our card each month. But, as we contemplated moving to an all-cash system, we had to confront what we knew intellectually but hadn't considered practically: that, if you pay your card on the due date each month, you're really two months in arrears. You have the month you're currently spending on, and the previous month for which you have the statement and the bill. This works out fine if you intend to keep paying your statement balance every month, but if (as we have for years) you do all your spending on the card, then when you decide that you want to switch to an all-cash economy you're faced with, well, debt.

So. Today is the first payday of the new year, and it's the day for the switch. We plan to follow Ramsey's basic outline, except that we're not going to pay down the smallest debt (the dryer -- which is at zero interest for another 8 months anyway) first. First, we're going to get out of credit card debt.

UPDATE: (A word from Darwin) The really tough thing, contemplating all this, has been accepting the idea of ceasing to use the credit card, going to an all cash budget, and then paying off the credit card over a series of months as a debt. I don't think I'd realized up until I contemplated this how much of my pride is wrapped up in the words "I don't carry a balance." Sure, at several points in our marriage, after a major expense (giving birth, etc.) we'd carried a credit card balance for a couple months, but in each case we'd budged very aggressively until we were back to paying off the entire credit card every month. I drew a lot of pride and satisfaction from thinking (when I read about how the average household carried 10K+ in credit card debt) "But we don't have a problem, we don't carry over a balance." thus putting ourselves in the group who cash in credit card rewards (in our case, we get Amazon gift certificates equal to 1% of our purchases) while never paying interest or fees.

The kicker, however, was realizing that if we ever had a major financial emergency (like if I lost my job) we'd have between one and two months complete spending already out there. Suddenly we'd be carrying a pretty substantial balance. And so we gritted our teeth and made the decision to step off the carousel voluntarily now, rather than finding ourselves pushed off at a time when it would represent a major crisis rather than a budgeting choice.

Rent or Own

Home ownership hath its tired and grubby moments, as I've had time to meditate on over the last few days as a playroom to bedroom conversion project has dragged long over the expected timeline due to general holiday business (and perhaps laziness, but we'll ignore that). On the other hand, if we rented our house we doubtless wouldn't have the wood floors, the newly blue bedroom, the green kitchen, the red walled living room with finished wood trim, or the re-tiled (though admittedly still un-mantled) fireplace.

This morning I was reading over Megan McArdle's reaction to a New York Post column which pushes the benefits of renting over owning.

It strikes me that there are really two trends which make owning a house look less attractive to many people these days:

1) Perpetual Debt: A great many people seem to have no intention of ever paying off their mortgages and owning their homes outright. Mounting equity is taken as a sign that it's time to move to a more expensive house, or take out a second mortgage. At that point, I can see how home ownership would be unattractive. However, if you actively work towards the day when you own your house free and clear (and make that an absolute condition for retirement) then there are huge financial reasons to own.

2) Geographic Mobility: In certain layers of society, it's become increasingly common for people to move pretty regularly, not only in a region (from starter home to larger home) but from one region of the country to another as career changes demand. When you move frequently, especially due to circumstances that have nothing to do with your real estate finances, you're invariably going to get clobbered by regional market fluctuations and the costs of selling/buying a home, and if you tend toward 30-year-very-little-money-down mortgages, the clobbering can be very bad indeed.

These factors aside, I'm always a little perplexed by the "it's actually more economic to rent than own" arguments. While perfectly efficient markets don't exist, it still stands to reason that rent must generally be higher than the cost of buying an maintaining a house -- otherwise there would be no landlords because they'd all lose money. So unless there's some major difference between how you approach house buying versus how a landlord would do so (and holding a house for only a few years and taking out more debt whenever your equity builds would definitely count as acting differently from a landlord) it stands to reason that you'd spend less money buying than renting.