With student debt reaching record highs, college costs outpacing inflation, and a never-ending stream of stories about struggling borrowers, taking out loans for higher education may end up defining your life.
On average, the class of 2018 students graduated with $29,800 in outstanding loans, according to Student Loan Hero. Over a standard 10 years, the $310 monthly payment for that debt is affordable for only eight of the 20 most popular majors in the U.S., according to an original analysis by Cashay.
“The government will often loan you more than you will be comfortable to pay back,” Sarah Newcomb, Morningstar’s director of behavioral science, told Cashay. “There's no real calculation of whether or not the loan is more than you will be able to comfortably afford, given what you plan to study.”
But approaching student loans the same way as you do your grocery-shopping might help, experts say.
How to get ‘a good deal’
Unlike auto loans, personal loans, and mortgages that are underwritten by a bank and consider your income, assets, credit score, and ability repay the loan, federal student loans are based only on the level of education you're getting and don’t account for your major.
Many borrowers assume the lender calculates what will be affordable to them after graduation, but in reality, that doesn’t happen. These borrowers get in trouble because they believe the loan amount they qualify for is proportionate to the future salary their degree will give them, Newcomb said.
Higher enrollment and rising tuition have driven the growing student debt in the U.S., but recently longer repayment schedules have also become a key factor, according to a new analysis from Moody's Investors Service. Only half of federal borrowers with repayment obligations that started in 2010 to 2012 have reduced their balances after five years, the report found.
But borrowers can prevent a life of debt by applying the 8% rule when choosing a major and applying for student loans.
“We really need to think about a degree as a product that we're buying,” Newcomb said. “When you're buying a product, you want to get a good deal.”
How much debt can you afford?
The rule is simple: Your monthly debt payment shouldn’t exceed 8% of your starting salary, according to Newcomb. This rule of thumb originally came from research conducted for the Journal of Student Financial Aid.
The study followed 2,000 college students after graduation, and researchers found that contributing students could comfortably pay back their debt in the standard 10 years if they contributed no more than 8% of their pretax income to the monthly loan payment.
That means if you pursue a social services major, you shouldn’t borrow more than $25,700, according to Cashay’s analysis based on the monthly payment and starting salary for the degree. But if you study engineering, you can borrow up to $42,300 and still have affordable payments after graduation.
Cashay found 8% of a major’s monthly salary for each major and then calculated the maximum loan about based on the monthly payment, taking into account the federal loan rate and a 10-year term. Cashay used data from the National Center for Education Statistics for 2016-2017 to find the most popular majors. The average starting salary by major came from PayScale’s most recent data.
Loans are a necessity
The 8% rule is important because, as the education system works now, loans are a necessity for most potential college students. Most colleges are unaffordable without a loan for 4 in 5 students, according to a 2017 report from the Institute for Higher Education Policy.
“When states cut their per-student funding for higher education, students and families must make up the difference by paying for increased tuition,” said Mamie Voight, vice president of policy research of IHEP and the report’s author. “For low-income students, the results are especially stark.”
On average, low-income students need to finance an amount equivalent to more than 150% of their family’s annual income to attend just one year at a four-year college, Voight said. By contrast, high-income students only need 15% of their family’s income to finance their degree.
While student loans offer a mechanism to pay for college, they do not actually address affordability.
“Loans don’t change how much a student must pay,” Voight said. “But rather change when the student must pay”
Making the math work
Not all majors are created equal. Some have riskier careers paths and require more consideration when applying for a loan. You may want to be cautious and adjust the 8% lower for the following:
Lumpy incomes: Careers based on commissions such as real estate and some sales positions may present more obstacles to repay debt when you have unpredictable cash flow.
Low pay: Careers that traditionally pay smaller salaries like social work and early childhood education make it hard to take on more than $26,400 in debt, according to Cashay’s study.
Slow salary growth: Careers that take a long time to launch and make a steady income – such as those in the arts – may make it hard to repay more than $26,900 in those first 10 years after college, according to Cashay’s analysis.
If you need loans and your intended major won’t support much in debt, don’t abandon your preferred degree just yet.
Consider starting at a more affordable two-year community college and transferring to a four-year institution to cut down on the loans you need.
Or, don’t go straight to college after high school, and instead get an employer-supported education, where your employer pays all or part of the cost to attend college or university classes. More than half of employers in the U.S. offer undergraduate or graduate tuition assistance, according to the Society for Human Resource Management’s 2019 Employee’s Benefits report.
Some of these majors that can’t support higher loan amounts don’t necessarily require a degree, either, Newcomb said. Consider apprenticeships, trade schools, and certifications to learn highly marketable skills without having to invest the same amount of money and time as college.
“A lot of people could really benefit from breaking out of the mindset that a four-year college degree is even necessary,” Newcomb said. “There are lots of great solid middle-class careers that require marketable skills, but not necessarily a degree.”
Denitsa is a writer for Cashay and Yahoo Finance. Follow her on Twitter @denitsa_tsekova.
Read more information and tips in our Student Loans section