• The last edition of The Personal Finance Project, discussed metrics to look at when considering colleges and trade schools. If you spend money – especially borrowed money – make sure that you are receiving value in return.
• You are the one who will be paying the bills, maybe for a decade or more. If you want or need a degree, get it, but take great care to avoid overpaying.
• Apply for scholarships and financial aid. Start looking as early as 9th or 10th grade.
• Know the difference between Sticker Price and Net Price.

And remember – the world of higher education is full of great and competitive options. Schools want you!

In Part 1, we encouraged slowing things down. Never let pressure (or even your parents) rush you into something – especially borrowing many thousands of dollars for your 1st major financial decision – if you do not have a solid plan for how that will clearly play out to your economic advantage. Think like a business. Be the CEO of your own life. If you borrow, make sure it is for a good investment that will pay for itself, several times over.

Get the facts needed to understand what you are doing and to feel confident. Make any decision carefully. Have eyes wide open before signing up for student loans. Because there are consequences.

In this edition, we’ll talk about some consequences to keep in mind, bad and good, that can often happen on the other side of student loans. For example, have you thought about how student loans can impact your ability to buy a home or invest for financial freedom? We want to show you why you need to think carefully about taking on debt. It is a mistake to think that a college degree guarantees wealth, regardless of cost. We’ll also get “nerdy” taking a look into the math of what it takes to breakeven or, better yet, come out ahead on borrowed money for school decisions.

For us, this is personal. At Troutwood, we have both recent grads and parents with children fast approaching college age. Like thousands of students we have spoken with across the nation, our own daughters and sons have many hopes and dreams. Though each student is undoubtedly unique, some dreams feel universal. For example, most hope to own a home someday. Student loans can affect that goal. Nearly all aim to become financially independent – often aspiring to do so at a younger age than their parents. Student loans can affect that goal of financial freedom, too.

How can Student Loans impact Buying a Home?

Let’s start by taking a look at the dream of buying a home. For the uninitiated, homes are pretty expensive. According to Business Insider, as of June 2023 the median “starter home” in the U.S. cost $243,000. Assuming a 20% down payment, a 30-yr fixed rate mortgage, a super-prime rate of 8.0%, and Bankrate.com estimates for property taxes and insurance, the projected payment would be about $1,652/mo.

Now, getting a mortgage isn’t that simple. Most lenders have rules regarding Debt-to-Income ratio (DTI) – the percentage of a prospective borrower’s gross income used to cover payments for things like the desired mortgage, property taxes, insurance, auto loans, credit card debts, personal loans, and (you guessed it) student loans. Stated bluntly, the greater a percentage of income that you must spend covering debts, the less a bank will be willing to lend.

The maximum DTI allowed for conventional home mortgages is usually capped at 36.0%. To understand the significance of DTI, let’s use an example, comparing hypothetical “College Grad A” vs. “College Grad B”. Both want to buy a $243,000 median “starter home”. Both earn a starting salary of $60,000, roughly the national average. Both have used cars, with a recurring payment of $528/mo (Bankrate.com – national average for used cars). And both have, by hook, crook or the generosity of relatives, come up with the 20% down payment. Everything is the same. Same interest rate, and so forth.

The difference:

College Grad A has $0 of student loan debt.

College Grad B owes $37,338 (the national average, as of 2023), with a 10-year term, a fixed interest rate of 5.50%, and a payment of $405/mo.

How might a bank look at things?

College Grad A, at a 36% max DTI, could be approved for a mortgage of $173,353 – enough to offer around $216,691 for that “starter home”. In this market, maybe they get it. College Grad B, unfortunately, would only be approved for $118,158 – they’d be out of the running, only able to offer $147,697 (31% less).

To qualify for the same mortgage amount, despite the student loans, College Grad B would have to earn a much higher salary – about $73,500/yr (+22.5%).

Now, imagine that Grad A and Grad B are the same person, just looking at different school options for the same degree – with the second option costing $37k more over four years. Maybe there is a perception that the more expensive school (or school that gives less aid) is “more prestigious” or “better”. Will the starting salary be +22.5% better? It might need to be, to justify the opportunity cost. If you’re asked to pay extra, is it wrong to expect extra? If loans being considered come at a high enough cost, you may need assurances that the ROI will be there for you – because the loan payments will be there, regardless. These are the questions we hope high school students are thinking about as they make their 1st major financial decision.

If you’ve been paying attention to the math, you may have noticed the huge significance of the auto loan. Too often, new grads are tempted to splurge on a car with borrowed money. If your goal is to own a home in your 20’s, minimizing or avoiding auto loans or leases is probably a smart move. As my colleague, Gene Natali often says,

"The four biggest sources of money mistakes are credit cards, student loans, autos, and homes."

This is also a microcosm of how homeownership is becoming delayed until increasingly later in life, and how generational gaps in homeownership and wealth can occur. According to the National Association of Realtors, the average age of first-time homebuyers hit an all-time high of 36 years in 2022 – up from 33 in 2021. It was just 29 years of age in 1981. More young Americans are going to college, but more also must contend with student loans as an obstacle.

The chart below illustrates the income needed to qualify for the same starter home referenced above, with the same mortgage rate and term, at different levels of monthly debt payments (student loan, auto loan, etc.)

How can Student Loans impact chances of Financial Freedom?

Next, let’s talk financial freedom. What does that mean? Having $1,000,000 someday? Given inflation, and looking a few decades out, maybe closer to $5,000,000?

It goes without saying that dollars spent making student loan payments are dollars that cannot be used for something else, like investing in a brokerage account, IRA, or 401k.

If it is true that the average student loan payment is around $400/mo for 120 months (10 years), think about something. If the same $400/mo was invested, what could that be expected to grow into instead?

Using a 10% annualized rate of return (as a quick and dirty proxy for the S&P 500), that $400/mo could grow into $81,938 by the end of 10 years. Then, without any additional investment after Year 10, it could increase to $221,810 after 20 years, $600,448 after 30 years, and $1,625,437 after 40 years.

Said differently, if you forget to invest, an average student loan may cause you to be $1.6 million dollars poorer by the time you’re thinking about retiring.

That is significant because, according to data from census.gov and the NCES, the median career earnings total for individuals with a bachelor’s degree is $2,803,619, versus $1,576,058 for individuals with just a high school diploma. The gap in career earnings – of $1,227,561 – is less than the amount student loan payments could grow into if they were invested instead!

The point – while the higher income that may come with a college degree is great, any student loan debt is a hurdle that must be overcome. Just paying student loans, but forgetting to invest, might cause you to come out behind if your goal is financial freedom. This is especially true when individuals fall victim to “lifestyle creep” as the higher incomes that come with many degrees become entrenched in spending habits.

If you’re reading this – and already have student loans – don’t get mad. Get even. Take charge of your financial future by making a plan.

If you have education beyond high school, chances are good that you have above average income to help you achieve your goals. With a little effort, it is possible to create budget that covers loan payments while, at the same time, prioritizing investing ahead of discretionary spending to keep your financial freedom on track. Try it for free with the Troutwood App today and see what goals are possible!

Troutwood

A financial plan for life