What makes a good $30,000 debt from a bad one

That’s the average debt of a college grad – and on a new car

In personal finance circles, a loan that helps you pay for something that you expect to rise in value — or at least hold its value — is considered a good debt. A loan to finance a purchase whose value will never be recouped is considered a bad debt.

A car loan is bad debt. It may be necessary, if you need a car to function. But given that the eventual resale or trade-in value will always be less than you paid, it’s an expensive debt.

Student loans are good debt. The median income in a household where at least one adult has a bachelor’s degree is about double that of a household without a bachelor’s degree, according to 2019 Federal Reserve research.

Good debt pays off

OK, but what about having to go into debt to get that degree?

The Georgetown University Center on Education and the Workforce (CEW) recently took a stab at quantifying the value of a bachelor’s degree at 4,500 schools. Using federal data, the CEW estimated the future earnings value of obtaining a bachelor’s degree, based on a school’s typical cost to attend (called net price), the typical earnings of graduates, and the median debt incurred by students at that school.

The metric they calculated is called net present value, which is an estimate of the future earnings value of a degree, expressed in today’s dollars.

The average net present value over a 40-year career was $765,000 for a public four-year degree and nearly $840,000 for a degree from a private nonprofit.

(Search “Georgetown CEW college ROI” for the tool; scroll down a bit to find it.)

Among students who take out federal loans to finance an undergrad degree, the average at graduation is currently about $28,000 at public schools and nearly $31,000 at private nonprofit schools. In the third quarter of 2020, Experian Automotive reported that the average new-car loan was $34,625. (The average used-car loan was $21,500.)

And that doesn’t take into account that you buy a bachelor’s degree just once, while you will likely buy multiple cars over your adult life. A college education is the catalyst to a career that can provide ongoing satisfaction as experience breeds more expertise, responsibility and compensation.

How to borrow smart

Let’s start with cars. Given it’s a depreciating asset, aim to borrow the least amount possible over the shortest loan term. That, of course, is an argument for buying a used car. A new car loses about 40% or so of its value in the first few years. Buy a car that is a few years old, and you’ve effectively let someone else pay for all that depreciation.

As for college, start with thinking through what type makes sense. While a degree is a worthwhile investment, that doesn’t always mean a four-year degree. There are many careers that are well-served by a two-year associate degree.

It’s critical to focus on schools whose net price won’t financially overwhelm your family. Every school must publish the net price to attend — what people pay vs. the advertised price. A private university’s net price can be half its advertised list price.

How much should you borrow?

A solid rule of thumb: Borrowing to obtain a degree should not be more than the first-year salary of the graduate. Follow that rule and it should not take more than 10% of the grad’s income to pay back the loan in the standard 10 years.

There are two types of loans, federal and private. Federal student loans are best. They have an embedded guardrail, in that total borrowing for all years of college is limited to $31,000. And for the record, the student should always borrow before the parent. Rates for student loans are better than the terms for a federal parent loan through the PLUS program.

And think long and hard about graduate degrees. This is where borrowing problems crop up. Unlike undergrad degrees, there are no borrowing guardrails. The basic federal grad loan program allows a total of $138,500 in borrowing. And if that’s not enough, graduate students can also take out federal PLUS loans, which can be for as much as you need to attend any school.

It is rational and reasonable to question an economic system that requires a college education for so many career paths, and yet also requires so many to go into debt just to participate in that economy. Yet an important bit of perspective is that reasonable borrowing for college tends to more than pay off over the long term.

Homeownership is still a great investment

For many, the loan they take out to finance the purchase of their home is likely going to be the biggest debt they ever take on. Homebuying, however, continues to warrant its elevated position in our society as a key way to build long-term wealth while contributing to the well-being of communities, families and individuals. Simply stated, homeownership is foundational to American life. While housing markets will invariably go up and down over the course of several years, “home as investment” is as strong as ever.

If you’re worried about taking on the responsibility of a mortgage, and if it’s a good investment, talk to one of our expert loan officers. They know your particular housing market and will help steer you in the right direction.

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