Tuesday, January 20, 2009

A Few Thoughts on College Debt

A few weeks back I was having a conversation with my little brother about our mortgages. I mentioned that Tonya and I were noticing that, with so little buying and selling in the market these days, combined with the tightened lending standards that are thankfully back in fashion, combined with the Fed trying to shovel dollars out of of helicopters to keep the economy propped up, it was actually possible to get some really good long-term fixed rates, if your credit is good. We mentioned that we were considering refinancing our current loan at a lower rate--seeing whether we could shave a few hundred dollars off per month, or reduce the time left on the loan.

My younger brother--who'd worked for a time in the registrar's office at Pepperdine University and who understands the way college financial aid works (and who, for that matter, had plenty of first-person experience with it himself), strongly counseled against reducing the term of our mortgage.

The trouble, he said, was that it would affect our chances of getting financial aid for our kids when it came time for them to go to college. The universities look at the parents' taxable income when they make their aid calculations, he explained; so if you pay down your mortgage early, you aren't taking as big a mortgage interest deduction by the time your kids are applying; thus, your income looks higher, and you don't qualify for as much aid, and so you have to pay a lot more out of pocket.

I've been chewing on what he said over the last few weeks, and the more I think about it, the more it rubs me the wrong way. It's not that he's wrong, mind you--I have full confidence that he knows exactly what he's talking about here. But it still rubs me the wrong way.



I don't trust debt.

Now, I know intellectually that debt can be a very useful tool, if it's handled properly. There are times that taking out some debt is a wise thing to do. There are times, for instance, when an expenditure of cash now can eliminate an ongoing expense in the future. Tonya and I did this when we bought our house and stopped renting. Given enough time, our mortgage payments will be lower than what our rent payments would have been. Another example that Tonya and I did was that we financed the replacement of our low-efficiency windows and our HVAC unit, in the expectation that it would improve our energy bills enough to offset our debt service. There are times when the use of debt is useful, even wise.

And yet...

My wife and I have a typical 30-year fixed-rate mortgage, and we owe in the six figures. On paper this is a much better arrangement than when we were renting--after all, the amount we're paying in interest now is about the same we were paying in rent then. We've just replaced one expenditure with another, right? And at the same time, we're building up our ownership interest. But at the same time, there's still this feeling of something not quite right here. Being debt-free, the way we were before we bought the house, gives a feeling of freedom. Yes, we had bills, and we had jobs to help us pay those bills, and we had leases. But there was still this sense that if we wanted to, if we felt we had to make a life change, we could walk away from it all and start over.

Not so anymore. Now that we owe our house, that job I have becomes a whole lot more crucial. I've got a whole lot less margin for error than I previously did, because the stakes are higher. I don't have the freedom anymore of just picking up and moving to a new state if I want to; there are a whole lot of other parties out there who have a claim on my income, and my home, and my very existence.

So even though it made sense from an intellectual standpoint for Tonya and me to take out that big mortgage and buy the house, it still feels, well... insecure. And she and I will celebrate when the day finally comes, some day in the far, far future, when burn that mortgage.


The trouble is, society is conspiring against us as we attempt to get out of debt. It's not just that (until recently) credit has been ridiculously easy to come by; Tonya and I have simple tastes and aren't tempted to spend until we're in over our heads. Rather, it's because of little quirks like what my little brother pointed out to me: our society assumes that everyone is going to leverage themselves to the gills--and considers people odd, even selfish, if they don't.

Selfish? Of course! What happens if the parents of a college-age son have a $300,000 house which they own free and clear? Why, to pay for that education, they are expected to leverage it--put it back under mortgage so they can put their kid through college. After all, it's for the future! It's for their son! Who could be so heartless to deny their kid an education, just to uphold some abstract principle of being debt-free?

Of course, if the same parents had, instead, put off paying off the mortgage as long as possible, and squandered the money on adult beverages--well, then, the parents don't have quite as nice-looking a balance sheet, and the kid now qualifies for a whole bunch more financial aid.

Do you start to see my problem here?


Of course, that's not where my problem ends--especially when I think about the future that my kids are going to face, starting (gasp!) eleven years from now.

Tonya and I were lucky. I--perhaps due to lack of ambition (I fully admit it)--chose to attend a state college close to home. California has an excellent public system of higher education, and I took full advantage of it; by the time I graduated from San Jose State University with my four-year degree (which took me six years to earn--there's that ambition thing again), I owed nothing.

Not one dime.

Tonya's education was a little different. She wanted to go to Pepperdine University, but was concerned about the cost. So, she strategized: first, she went to a local junior college, and got her general ed. courses out of the way. Then she transferred to Pepperdine, and got the best financial aid package she could from Pepperdine. Tonya's mom was able to help out, by going back to work for a while; and Tonya took whatever jobs she could while on campus. She managed to complete her degree after two and a half years there, and graduated with not much more than $7000 in debt, tops--which got paid off (with a little parental help) before it started accruing interest.

In comparison to our stories, we found ourselves surrounded by peers (and relatives!) who had amassed debts of a hundred thousand dollars or more by the time they got out of college. In fact, one of Tonya's friends went to Pepperdine, then to a medical school, both 100% on loans--and graduated with over a million dollars in student debt!

Now that last one is an extreme example, of course; but still, we find ourselves horrified at the financial condition that so many students leave school in, and what this financial condition does to their well-being--not to mention how it affects the rest of their lives. It's not uncommon to read about young couples who start their marriages off with one or two hundred thousand in debt between the two of them. And if one of them loses their job, that interest starts accruing and compounding...

Sez I, that's no way to start a marriage. Sure, some people can make it work, but no one could call it ideal. When Tonya and I got married, we were debt-free. With no debt, with no kids, with Tonya's savings that she'd been building up during the previous few years (while she'd been living with her parents to save money), and with two employed people in the marriage, Tonya and I were able to save enough for a sizeable down payment on our current house, and so we were able to pay cash for the minivan when the Pillowfight Fairy came along. We can't tell you how thankful we were, and are, for the blessing of having started out debt-free.


I was thinking of all this today because I saw an article in Forbes (with a hat tip to Dr. Helen) about just this problem--changes in the education industry in the last two decades or so have been putting increasing financial pressure on the students and their parents. The price of higher education has been rising much faster than the general rate of inflation (and people's wages), and increasingly this gap has been filled by the educational equivalent of sub-prime loans.

All those people that Tonya and I knew who got out of college with six-figures of debt? Well, the problem has only gotten worse since then--and the interest rates are higher, too.

How is all this happening? Well, it appears to be a couple of things. For one thing, "College" has now become the new "High School". That is, where the high school diploma was once (a few generations back) seen as the necessary qualification to prepare people for the world of professional employment, now people with just a diploma are seen as having an incomplete education and insufficient qualification for most non-manual-labor jobs. As there is now a stigma attached to merely having a high-school education, the demand for college has soared. Demand goes up, so do prices--that's Econ 101.

Furthermore, the colleges have discovered that the more generous the government is with its grants and loans, the higher they can jack their prices and still have people shell out for it.

Add to this the fact that it's normal these days for people to use debt to buy everything, and to leverage themselves to the gills--between our mortgages, credit cards, car payments, etc..., and people don't think anything's unusual about applying for tens or hundreds of thousands of dollars in debt to finance their education. After all, we all reason, they are investing in their future.

The article makes the point that this investment often doesn't pay off as well as they expect. By the time you factor in the time value of the money they spend on college, and the interest on their debts, and the increasing competition for professional jobs by the burgeoning ranks of college grads, and the fact that high-school-only grads start earning four or more years earlier (and thus have four more years of experience by the time the college grads hit the workforce), a big chunk of the lifetime earnings premium for having a college degree just isn't there anymore.


I wrote back in December about the state of higher education in this country, at least as observed by Victor Davis Hanson, and touched on his foreboding that we're approaching a cultural tipping point in our views of what Universities are and what they're good for. I finished out that article thus:
And I think that at some point there's likely to be a backlash in the general population against the university system. Hanson claims that
While the public may not fully appreciate the role that classical education once played, it nonetheless understands that university graduates know ever less, even as the cost of their education rises ever more.
With a college degree currently being absolutely necessary to get into many professional jobs, and the current costs of higher education spiraling out of control, and a growing sense in the population that just because someone graduated from a University, it doesn't mean they're well educated, eventually something is going to break.

I, for one, am curious to see what that "break" looks like. I actually suspect it will be good for society, but I'm a hopeless optimist that way.
My guess is that the Forbes article I linked to above is a sign of the gathering backlash; the more people read and hear about the state of higher education and its costs, the more likely they are to want to do something about it; and this doing something may well involve substantial changes to the way we educate and train our kids, in a way that marginalizes or dis-establishes the University.


And about our mortgage?

We recognize that there may be ways of structuring our mortgage to game the financial aid system to our benefit. But Tonya and I have decided not to do this. Should we decide to refinance, it will be with an eye toward reducing our monthly payments or paying the loan off early, or both, as we see fit. We realize this may make it harder to make ends meet when the kids are college age. So be it! Our goal is to find those educational options like what Tonya and I had, so that neither we nor our kids are saddled with unreasonable amounts of debt by the time they have the education they need to survive in life.


marshymallow said...

I think there has to be a backlash. I'm attending college right now, and the system is so screwed up - the better my personal finances are, further in debt I am. I hate being in debt, but I just don't see any way out of it. It's like trying to swim acrost a whirlpool.

Roger Z said...

Tim- I agree with your financial decision 110%. My goal is to make sure that my kids can go to the college of their choosing, no questions asked, and hence it's one reason I save as much as possible these days. One of the greatest gifts I ever got- if not the greatest- was leaving college debt-free. And I know it's a gift, so I don't take it for granted, I want to do the same for my kids so that they can start off their adult life on the right foot.

I understand not everyone can do this, and maybe ultimately I won't be able to either. I don't begrudge someone who goes into debt to make a better future for themselves and their family. It is perturbing, however, that our higher education system appears to be subtly introducing moral hazard into family savings decisions. That should be investigated more closely by college financial programs.

B. Durbin said...

My parents told me two important things while I was growing up: 1. That I would have to pay for college myself; and 2. How to do it.

For part 2, the answer is "bust your butt in high school and then apply for every scholarship you see." I did graduate with debt, but it's entirely from living expenses— my tuition was 100% paid for by a combination of scholarships. And half of everything I earned as a teen went to savings bonds, so I actually had a little cash on hand when I graduated.

Yes, I'm still paying my debt but that's because I consolidated into a low-cost payment many years ago, and I've been working on clearing other debt first. We'd have had an easier time attacking it if a hit-and-run driver hadn't taken out our paid-off car a few years back just two months after the payoff (thus, no time to accumulate a better payment for the car we got.) But hey, it's at a level we can live with and can pay off before we're ancient.

I'm planning on telling my kids to do the same. Maybe they'll make it through debt-free.

B. Durbin said...

Incidentally, something I saw on HGTV stated that just by making an extra payment every year, you'd pay off a 30-year mortgage in 19 years. So if you restructure your mortgage, a new 30-year with no pre-payment penalty would work well for this; with the lower payments you could pay an extra or part of one every year, in effect reducing the term of the mortgage while still having emergency flex in it.

Tiffany @ Life on the Road said...

THANK YOU! I am so frustrated at the way debt is normalized in our society right now, and more so by the questionable moral choices that seem to come along with it. It seems like nobody cares - so I'm delighted to hear that you do, too.

By the way, another good trick for kicking your mortgage out early is simply paying half of your monthly payment midway through the month (and the other half at the usual time).

kat said...

There is also that feeling of relief when you own a house free and clear. No one can take it away from you or your family, you know that you will never be living in a box on the side of the road. That feeling is priceless.

We have no debt, no mortgage and I am always so grateful when I listen to Dave Ramsey on the radio. Just a few days ago a woman called, her new husband owes $90,000 in college loans and only makes $30,000- he got a degree in Spanish!! What a fool!

No matter what money we make or owe we will still look poor come college time since we have 6 kids.

I'm going to push the comm college, work, scholarship route- it is the only reasonable way to pay for it and have the kid get good grades (nothing like giving a kid a free ride to make them not appreciate it and drink/party their way through a degree!)

Great post!

Kim Anderson said...

Thoughtful analysis! Thanks for the Forbes link, too!

Roger and B Durbin, I'm with you! My goal for my children is for them to be able to have whatever advanced education they need to open the maximum number of future doors - WITHOUT acquiring a slave's load of debt.

My husband & I have a very limited income, but we have 2 children in college. Both of them are acquiring ZERO debt.

Sue said...

Now THIS is an excellent article! The whole debt issue has become a real hot button for my husband and me. We are working to pay off our mortgage, hopefully within 5 years - what a party we'll throw!

We are raising our grandkids, 17 & 18 & have no clue how college will be funded. But, in line with some of what you're saying, I question the validity of their needing to go. However, the pressure is so intense, from every direction, that one begins to feel like a total ditz to not consider college an absolute necessity.

(One things the kids are learning - we homeschool - is real life money skills, including the real cost of debt. Our church is offering one of Dave Ramsey's courses & they are taking it right along with us.)

So many college grads, in addition to the debt, hate what their doing, even though many are making big bucks. Tragic, I think. I recently posted about this on my blog.

The world has changed, is changing and in my humble opinion, the need for a 4 year degree is no longer an absolute. I don't care how many people look at me as if I had 2 heads :)

Oh, I could go on & on....

Your post was great - thanks!