Saturday, January 29, 2011

Four Simple Steps for Choosing the Right College, Part Two

Last week, I outlined four simple commonsense steps that you can follow for choosing the right college:

1. Decide what your career and life goals are.
2. Decide what type of education you need to meet your goals.
3. Determine what your financial budget is.
4. Choose a college which meets your educational and financial requirements.

In the first installment, I discussed the first two steps in detail.  In this second installment, I will discuss the third step.

Determine Your Budget

While education is a noble pursuit, it is a pursuit that requires cold, hard cash.  Many people (particularly first generation students) enter college with the idea that they will go to the best college they can without any concern for what the price tag is.  They figure that they will find a way to pay for it later on.  Of course, we have seen that this is a recipe for disaster.  Racking up student loans without forethought about how you will pay them back is worse than taking on a mortgage you can't repay.  At least with a mortgage, you can always walk away and allow the bank to foreclose on you.  There are many dire consequences to not paying your student loans:

- You can lose your tax refunds.
- You can have the loan payments taking directly from your paycheck.
- You can lose your Federal benefits.
- You can be sued (note that there is no statute of limitations on collecting student loan debt).

Bankruptcy won't help you because student loans are non-discharegable.  That means that even after declaring bankruptcy, you will still have to pay the full amount of your student loans.  On top of all that, Tennessee suspended the nursing license of 42 nurses who defaulted on their student loans.  The moral of the story is that student loan debt is something to be taken very, very seriously.  Taking on more debt than you can handle can have serious consequences that will follow you for the rest of your life.

The remedy for indiscriminate student loan debt is to have a reasonable higher education budget:

YOUR COLLEGE BUDGET =
Money saved for college +
Money earned working during college +
Money borrowed through loans

The first two items are straightforward to calculate.  The last item requires some thought.  You have to determine how much you can borrow realistically.  Here is my humble suggestion:

The Federal Housing Administration has a set of debt guidelines for determining how much a person can borrow towards purchasing a house.  The guidelines are as follows:

1. Your monthly mortgage payments should be no more than 29% of your total monthly gross income.
2. The total monthly payments on your loans (mortgage, credit cards, student loans, etc) should be no more than 41% of your total monthly gross income.

That means that 12% of your income is for payments on things other than your mortgage.  My suggestion would be to assign half of that amount towards student loans (6% of your monthly gross income).  That leaves you a buffer for car payments and credit card payments. 

Now what you do is estimate what your monthly gross income is going to be in your chosen field, take 6% of this number, and this is what you can reasonably afford to pay every month towards student loans.  You can use a loan calculator (like this one) to determine how much of a loan you can afford to take.

Here is a quick example:

Let's say that you estimate that you can going to make $5,000 a month ($60K per year).  That means that you can afford to make a monthly payment of $300.  If the current Stafford loan rate is 6.8% for a 10 year loan, that $300 a month will get a loan amount of $26,087.  Therefore, you should budget for loans in the amount of $26,088.

To put it into a formula:

Total Maximum Loan Amount =
(Expected Monthly Gross Income) * 0.06 *
(10,000 / monthly payment for a $10,000 loan)

Here is the math for my example:

Total Maximum Loan Amount =
(5000) * (0.06) * (10000 / 115) =
$26,087

Now you might say that you won't have a mortgage so why not use the 29% that the FHA budgets for your mortgage payment for student loans?  Then you'll be able to borrow more.  While it is true that you may not have a mortgage, you will still need to pay rent.  This gives you the flexibility to budget for your rent without breaking the bank.  Of course, your mileage may vary, so feel free to adjust my guidelines to fit your needs.  My main message is that you need to consider what you are reasonably afford to pay back.  You can't just borrow, borrow, borrow.

In the final installment in this series, I will discuss the fourth step which is choosing a college.  Stay tuned!

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