How do people rack up those huge college loans?

Posted on November 9, 2018November 9, 2018 by Danielle

Recently over lunch and some very good small batch cider, a colleague asked me, How on earth do people rack up these big loans when there’s a limit on federal loans? It was a very good question: I’ve seen some humongous student loan debt, but I decided to go back over client profiles to really check out where it all came from.

First, some basics; as an undergraduate, you have six options for borrowing to pay the cost of attendance:

Direct Subsidized Loans

These are available for undergraduates who can demonstrate financial need. The borrowing limit on these is $3,500 freshman year; $4,500 sophomore year; and $5,500 for junior year and beyond. So, in four years you could borrow $19,000, and theoretically if your program is 4 years, you can borrow up to 6 years if it takes you that long: $30,000.

Direct Unsubsidized Loans

$5,500/$6,500/$7,500. If you’ve qualified for subsidized loans, these are the upper limits for total amounts. So if you qualified for $3,500 in subsidized loans in freshman year, you could borrow another $2,000 in unsubsidized loans. If you couldn’t qualify, you could borrow $5,500. So the total in four years would be $27,000; take 6 years and the total limit is $31,000.

This level of borrowing is where I’d encourage a full stop. With most bachelor’s degrees, you need to keep a sharp eye on your likely first year salary, and that’s the standard for the limit I recommend borrowing.

Find the definitive word on federal student loans here.

Some schools have a loan program. This is much more rare for undergraduates, and limits can vary.

PLUS loans. These are available to parents of dependent undergraduate students, and directly to graduate students. The maximum is the cost of attendance, and here’s where we get into the whopper amounts—we’re talking not only tuition, but also fees, room and board, and books and equipment. The undergraduate cost of attendance at Northwestern University for 2018-2019 was $75,753. If it doesn’t go up a penny for your four undergraduate years (unlikely) you and your parents could end up owing $303,012 and I guarantee no first year job is going to offer you that salary.

Parents should think long and hard before taking these loans, and in my view almost NEVER should. What if the student drops out? Gets really ill? Goes biking around the world to find themselves? Has a major car accident? Huge investment down the drain, and it happens all the time.

Private loans. Think a long, long time before you take these. They generally appeal to people whose parents’ credit is so bad they can’t qualify for a PLUS loan, and sometimes entice borrowers by offering variable interest rates—low at first, but then watch out. Be sure you understand repayment terms and when repayment begins—sometimes, immediately.

Home equity loans. Parents (and very occasionally, older students) may be able to borrow against home equity. With the new tax laws, these loans are probably no longer deductible. Don’t, just don’t.

So we can immediately see the real dilemma—if you don’t have savings, you’re in real trouble. If family income is really low, then you should get aid. I’d recommend choosing a college primarily on that factor—how much are they offering you? On the flip side, if you have high income but no savings, you ought to be able to pay from current income, but again college choice should be pragmatic, and you should be looking at a public college unless you can wrangle some kind of merit aid from a private school (not likely, but possible at some schools). Many schools now have a policy that aid is 100% needs based. That may or may not be actual practice. Private school aid always involves “professional judgment” from the financial aid office.

Now let’s look at the most common ways you can accumulate crippling debt.

Borrowing for living expenses

This can really run up the bill. Anyone who needs to borrow money should be choosing the least expensive living accommodations. Usually, that means the dorm. Sure, rent may be cheaper at first glance, but you also have utilities, internet, food (and you’ll end up eating out more often), maybe more transportation, security deposit; be sure you figure all costs that would be provided by the dorm.

If at all possible, a student should have a job. Research has said that the student who works 10 hours a week is better organized and often does better academically than the student who doesn’t work, or works too much.

The real problem with mounting living expenses is someone who is ill, has non-covered medical needs, or whose program is too demanding (usually grad school) to work. As an undergrad, this should definitely be raised with financial aid for “professional judgment”. Grad schools don’t care.

Choosing an expensive school

If you have to borrow more for 4 years than you can earn in the first year of employment, choose a cheaper school. Pretty much no exceptions. Most BA degrees don’t buy you huge salaries, so you don’t want to shoot your whole financial future on just a BA.

The three most important factors are who you are, where your last degree is from, and (if the field requires it) what professional certification you earn. Do you really care if a neurosurgeon got their BA from State U? Many, many CEOs and inventors have graduated from public universities.

Choosing an expensive graduate program

If it’s a professional program, you should know what the employability of the field is. If there’s a public option, take it.

If it’s an academic discipline, and they’re not paying for you, they don’t want you. Employment from graduate programs is abysmal, and statistically you’re not going to get a job as a professor without some extraordinary achievement or other practical experience that sets you apart.

Too many people stay with school because they don’t know what else to do. You’re paying for the privilege.

On the other hand, if you borrow $300,000 and walk out into a job that pays you $150K with a $200K bonus (okay, you’re a doctor), you’re probably okay. It’s not the money you borrowed, it’s what you can earn with the degree. Like any investment, it’s worth putting money in if the ultimate payoff is worthwhile.

Similarly, the BA who’s borrowed $25K has borrowed as much as if they purchased a new car. This is a doable payoff, but only if you have a job. Even better if you can cut your living expenses radically for the first few years so you can also build an emergency fund.

Most huge debt I see comes from graduate work, not undergraduate. Carefully consider the field, and maybe consider working awhile before going directly to graduate school. Hey, you might even find an employer with tuition reimbursement.

Not having a part time job

Even if you can cover everyday spending by working some dumb job part time, you’re going to save a lot of loan expense. Is that latte worth $10?—because that’s about what you’ll pay with a 10 year loan.

Dropping out before finishing

Even worse if you drop out before graduating or take more than 4 years to complete. Any time you put payments in abeyance, the interest charges balloon. People who take time off, move in and out of loan payment, etc. can see their payback amount easily double over time. Remember, the interest is ticking continually: just because you’re not paying it now doesn’t mean it’s gone away. It’s growing steadily like mushrooms in the dark.

Dropping out before finishing also involves a hidden cost—lost opportunity. You already have lost opportunity—even with a free ride, college costs you what you could have been earning by working instead. But a partial degree is worth next to nothing in the job market (for most fields), so you’ve borrowed a lot for nothing. Or, if you’ve changed majors or taken time off, you’ve paid far more in extra years of tuition (and living costs, and lost opportunity) for the same degree. Stick it out—add a minor, or suffer through. Life isn’t perfect–just wait until you get the first crummy job or boss that hates you and you have a huge loan payment to make.

Ignoring the payment or taking a payment scheme

The loan never goes away, and it keeps building. Most of the forgiveness programs haven’t worked. And, if you have any kind of professional license, it can be yanked if you don’t pay. Ignoring it only makes it worse.

IMHO we have a really broken system for paying for what has become virtually essential higher education. Until and unless that changes, we have to work the current system as best we can, and that means making some very pragmatic choices. Don’t get so snagged on the college of your dreams that you close off any possibility of fulfilling after-college dreams.

Money is not yet virtual

Posted on November 5, 2018November 5, 2018 by Danielle

According to dear daughter I’m a world class know-it-all, but every once in a while it’s brought home to me that I don’t actually know everything. So this is another chapter in the ongoing saga entitled, I Make All the Mistakes So You Don’t Have To. Herewith we have a cautionary tale about online banking.

Despite my advocacy for keeping on top of your finances, I must admit that I’m somewhat lazy about balancing my check book. Downloading statements has really nudged me up a notch on this, even though my bank has a somewhat cumbersome process on this—sometimes the magic works and sometimes it doesn’t. By that I mean sometimes Quicken will auto-download, and sometimes I need to go to the bank’s website and do it manually. I do manage to get to this, um, almost every month.

I have found, however, that occasionally there are transactions missing and I’ve been lulled into complacency since most of them tend to appear in the next month. But ugh, I’ve just had a major glitch.

Usually, I use mobile deposit for the checks clients write to me. These are occasionally rejected, because either I’ve tried to deposit too much money or I’ve exceeded the check limit for the time periods. It’s a nice problem to have, and a good excuse to walk the dog over to the bank, which she thinks is the biscuit store.

On those rare occasions when I actually get to the health club, I’ve used the drive-up window. One time a very large check did not appear in my account after the drive-up, and I noticed it immediately and it was found (it had been mis-deposited into someone else’s account!).

However, the computerized reconcile that I use for the business books had been carrying 4 relatively smaller deposits from month to month. The reconciling does get a bit off from time to time (double entered, missed a withdrawal, etc.) and I pretty much just ignored it until I started worrying about getting ahead of the end-of-year tiding up. So, I finally decided to compare these with the paper statement.

I still get the paper statements (although I’ll probably switch to the PDFs next year), because that’s where I’ve been able to identify the few transactions each year that don’t download. To my shock, these four deposits, all made on the same day, have never showed up. In re-contacting all the people who wrote the original checks, each reported that the checks were never cashed, and have graciously re-issued them. But I can’t take it up with the bank, because I don’t usually keep deposit receipts in a feeble effort to maintain a clean car.

What I’ve learned:

Keep your deposit receipts until you get your monthly statement, or at least until the deposit shows up online in your account.
If you use computer download/reconcile (does anyone still do it by hand?) be sure you double check anything that is still carrying over after you check deposits and payments. Anything that doesn’t check off should be verified with the bank.
Within a day or two after in-person, automatic, or mobile deposits, make sure they show in your online statement. Even robots make mistakes. Eyeball your paper or PDF statements that everything is there as it should be.

So, even though I embrace online banking, I’m still a little reluctant to eliminate paper statements. I find it’s much easier to ignore online and electronic information. True, the paper piles up into a mound near my desk, but at some point I can’t ignore it, and it does provide a follow-up trail. Make sure you have back-stops and double-checks in place before you go 100% virtual.

Calculating the worth of a job offer

Posted on October 3, 2018October 8, 2018 by Danielle

We’ve all heard that we’re moving to a gig economy. I think this used to be known as being a freelancer, but there are some important new wrinkles. If you’re thinking of accepting or have been offered this type of job, you need to get out your calculator and run some numbers to see what you should actually charge, and what’s a fair offer. BTW, this has come to my attention based on an offer made to my job hunting child—hourly or salary, with the hourly rate being slightly more. The employer making the offer was genuinely surprised when dear daughter turned it down; she said most people prefer the hourly because the rate was higher. No it wasn’t—at least not enough.

Let’s set up a case study for Sally Onherown. Ms. Onherown would expect to make $70,000 in a salaried position. That position would also include health insurance, short term disability insurance, an opportunity to buy into a group policy for long term disability insurance, paid vacation time of 10 days, 7 paid federal holidays, 3 paid sick days, and a 401k to which the employer contributes 3% of salary (provided the employee also contributes 3%). In 2018 there are 261 working days, so Ms. Onherown is making $268.20/day or $33.53 per hour (I’m using 8 hours, though a 9-5 job with a lunch hour is only 7 hours).

Let’s see what Ms. Onherown’s benefits are worth:

Paid vacation	$2,682.00
Paid federal holidays	1,877.40
Paid sick days	804.60
Employer’s 401k contribution	2,100.00
Value of health insurance (based on $424.26/month through ACA for a 20 something)	5,091.12
Short term disability (usually 1-3% of income)	700.00
Long term disability (let’s say you’d pay half of 3%)	1,050.00
Total value of benefits	$14,305.12

So, in order for a freelance gig to pay as much as a salary, Ms. Onherown would need to be paid at least 20.4% more: $84,305.12, or $40.38 per hour.

But wait, that’s not all. If Ms. Onherown is working out of her own home or apartment, she could deduct some portion of the housing as a home office, and any time she uses her car to travel to a site, the mileage would be deductible. But if all that hourly work is performed at the employer’s site, she loses that. If she has to use her car, she may get a gas allowance, but often these don’t take into account the wear and tear on the car, the cost of purchasing (and financing) a vehicle, the increased cost for car insurance when used for a job, and the inevitably increased maintenance on a heavily used car. And, does Ms. Onherown need to provide any of her own supplies? Depending on the profession, this can really rack up some costs.

While Ms. Onherown could certainly contribute to an IRA, without a match, the amount she could contribute (and the potential reduction of her taxable income) is far lower than the amount she might contribute to an employer 401k. While a single making $70K probably doesn’t have enough to contribute the full $18,500, these jobs are often pitched to married people (as “flexible”)—and if spousal income is sufficient, the couple is losing an important tax saving opportunity.

We’re probably wading into the weeds here, but are those hours guaranteed? Because if the client isn’t available, or there’s not sufficient business, or some time might be taken up with non-billable activities like staff meetings, the hourly person working directly for an organization might end up with far less than 40 billable hours. In fact, many true freelancers are lucky to be able to bill 20 hours per week. If it’s the kind of freelance job where you also need to join professional organizations, pay for professional insurance, do marketing, and supply your own technology (and technology repair and replacement), the costs are much, much higher than my list above.

Many years ago, when I worked at writing grant applications, the Feds used to allow us to include a “reasonable” indirect rate of 31-33% on any proposal to cover just these sorts of costs for personnel. I think that’s a good starting point—add about 1/3 to any salary, and you’ll have a pretty good estimate of what a minimum freelance hourly rate should be.

NOTE: An earlier version of this post used 216 working days instead of 261–an inadvertent transposition. The calculations have been corrected. I regret the error.