How much college debt is too much?

By Liz Pulliam Weston

Student loans are usually classified as "good" debt. Like a mortgage or a business loan, borrowing for education can be a smart investment in your future.

Too many of today's students and their parents, though, are taking a good thing way too far.

I get e-mails from readers who are $30,000, $40,000 or more in debt from student loans and who can't find work in their fields. Even if you graduate with the average level of education debt -- about $21,000, according to The Project on Student Debt -- you may be jeopardizing your finances. Many newly minted graduates find their loan payments are so big that they can't save for other goals, such as a house or retirement.

Four years of loans can last a lifetime

Putting off these goals to pay debt is an expensive choice. A 22-year-old's $3,000 Roth IRA contribution, for example, could grow to more than $95,000 by the time she's eligible for full Social Security benefits. Put off that contribution by 10 years, and her contribution will grow less than half as big, to about $44,000. Both examples assume 8% average annual returns.

It's up to you to put limits on how much debt you're willing to incur. As with mortgages, credit cards and most other kinds of debt, lenders are willing to give you far more money than you can comfortably afford to repay.

Students do face maximums on how much they can borrow under federal student loan programs. Private lenders have no such limits and will typically lend students, or their parents, the difference between their college costs and any financial aid they get. More are taking out private loans: Ten years ago, they made up 5% of education loan dollars; now it's 20%.

These lenders know they have a pretty good chance of getting paid back, no matter how rocky your post-college finances turn out to be. There's a much better system than in the past for tracking down defaulters, so it's harder to simply walk away without paying. And even though student loans are unsecured debt -- not tied to any asset, like a house or a car -- you typically can't have them erased in bankruptcy court.

How much can you safely borrow?

Knowing all that, how do you decide how much debt you should incur? Obviously, the less borrowing you have to do, the better:

• If you're a student, your payments shouldn't exceed 10% of your expected monthly gross income once you graduate.

• If you're a parent, all your debts -- including mortgage payments, credit cards, car loans and education loans -- shouldn't eat up more than 35% of your gross pay.

• Once you start borrowing, keep track of your debt. It's easy to get confused about how much you owe, particularly if you borrow from a number of different lenders.

How can you figure out how much your loans will cost when the interest rate is often variable? You'll be pretty safe if you figure on a rate of around 8%. Federal Stafford loans are scheduled to drop to 3.4% by 2011, but the rate is 6% for the 2008-09 school year. PLUS loans are at 8.5%.

(If you're a parent using a home-equity loan, your rates were fixed when you borrowed the money. If yours is a home equity line of credit, however, your rates are variable, so use an 8% interest rate to be conservative.)

At 8%, each $1,000 you borrow will cost you about $12 a month to repay, assuming a 10-year loan. If you're a student and you borrow the maximum allowed under current federal student loan programs -- $23,000 in subsidized and unsubsidized borrowing for undergraduates who are still their parents' dependents -- your monthly payments will be around $276.

That payment level should be manageable if you're making at least $33,000, which means you'd better be an accounting or business major. Starting salaries in those fields range from about $36,000 for business administration types to $43,000 for management-information-systems graduates.

Liberal arts grads, on the other hand, generally have to settle for salaries under $30,000 to start.

Continued: No heroics from the parents

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