Borrowing is often considered necessary in American life today. Cars, houses, home improvements and other major items can cost so much they simply can’t be paid for with available cash. So it’s not surprising that with the price of college today, many parents feel they have no choice but to take out loans to finance their child’s education. Yet that increased debt can lead to some serious issues.
How much debt can a family handle?
According to most banks and financial advisors, a family should have no more than 30% of their income going to housing expenses plus debt of any kind. This includes a home mortgage or rent, property taxes, car loans, credit cards and other debt.
By definition, that “other debt” would include loans to pay for undergraduate and graduate school, and the general rule of thumb there is that student loan payments should take up no more than 10% of a family’s income – leaving the remaining 20% of income to pay for all the other debts
Questions to ask yourself about borrowing
You may feel strongly that your son or daughter needs a college education to succeed, so borrowing money to put them through school might feel worthwhile. But which school? Websites and online groups are full of parents saying things like: “But my daughter has her heart set on going to this big name college, and I don’t want to crush her dreams.” Here are some ways to look at the situation:
- Is going to a specific college a NEED or a WANT?
- Could a less costly college provide similar benefits?
- What are the long-run financial tradeoffs? Could paying more for college – plus the higher interest payments -- result in less money for a car, a house or apartment, everyday expenses, etc.)
- What is the impact on your retirement plans? Would you need to work more years to earn the money to pay off the loan?
- Could your spending years paying off a large loan result in your child supporting you in your later years?
- What impact might a larger loan have on your credit rating if it became difficult to pay?
Setting limits
Although College Money Matters does not provide legal, certified financial, or any professional advice (see our Terms of Service page), we do offer these three suggestions:
- Figure out your financial limits and have several open, honest discussions about them with your college-bound kid. You may even find you share more common ground than you think. See: How to have that discussion about paying for college.
- If loans are necessary, try to keep the amount down to what the Federal government offers in student loans, which is currently around $27,000 for four years.
Keep in mind that experts recommend that monthly student loan payments should not exceed 10% of your paycheck.
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