Its easy to see why one of the top Google searches is how much college debt is too much? After all, there is now $1.6 trillion of college debt in the United States.
Many try to answer this question by comparing your expected increase in income post-graduation relative to the cost and say a break-even in less than 10 years is good. For example:
- If you are expecting your income to increase from $40k to $60k a year; and
- Cost of going to school is $100k.
The break-even will be $100k/$20k which equals 5 years (the $20k is $60k – $40k from above).
This method of answering the question regarding how much college debt is too much is flawed however. It completely ignores risk factors to your finances. For example, various degrees reduce risk to employment more so than others. The higher you go, i.e. bachelors to masters, does the same thing. In short, risk to your income is not equal.
In addition, it also ignores the interest rate on your debt. This can greatly increase or decrease the cost of debt.
Another method I’ve seen says if your debt payments are 8% to 10% of your income, its worth it. This should put you on pace to pay off your college debt in about 10 years. However, this is also tremendously flawed due to the introduction of income-driven repayment plans.
Therefore, both ‘traditional’ methods of answering how much college debt is too much are flawed.
The Best Way To Answer The Question
The best way to answer how much college debt is too much is to incorporate the affects of risk to your income as well as how you repay your loans, i.e. incorporate the use of income-driven repayment plans.
To do so, you have to calculate how much your human capital value increases or decreases by going to college and using debt to finance it. For example, if you say your going to have college debt of $100,000 and the value of your human capital decreases, then you are using too much debt!
I provide more details of this below.
How To Calculate Human Capital
Calculating the value of your human capital is extremely difficult. However, we made it easy.
To determine how much college debt is too much, we will be using FitBUX’s technology.
Some of the things involved in the human capital are your degree, income, amount of loans you have, your age, and even things such as whether you speak a second language.
To see what your human capital value is, simply become a free member of FitBUX, build your profile, then navigate to the net wealth section of your profile. If you want to see how much debt is too much, schedule a call with a FitBUX Coach and they can help you use our tools to figure it out.
Below I walk through a handful of examples so you can see how much college debt is too much. If you’d like to see actual examples, check out our analysis on becoming a DPT.
Scenario 1: Undergraduate With No College Debt
We need a base line to compare against. Therefore, this first scenario serves as our baseline.
Assume you have an undergraduate degree making $48,000 a year and have no college debt.
Your human capital value is $439,000.
Scenario 2: Graduate Degree With No College Debt
The second scenario will be someone with a graduate degree making $78,000 a year and no college debt.
Your human capital value is $821,000.
Therefore, the value of your graduate degree is $382k ($821k – $439k). Obviously, getting a graduate degree and not having college debt once your graduate is worth it.
Now we will look at scenarios that include college debt
Scenario 3: Graduate With $100,000 In College Debt
The third scenario will be someone with a graduate degree making $78,000 a year but with $100,000 in college debt.
Your human capital value would be $768,000. This is still significantly greater than our baseline in scenario 1 so you’d say yes, 100k in college debt for this graduate degree and $78k in starting pay is worth it.
Scenario 4: Graduate With $210,000 in Student Loan Debt
The fourth scenario will be someone with a graduate degree making $78,000 a year but with $210,000 in student loan debt.
Your human capital value would be $460,000. Technically, this is still more than our scenario 1 baseline so it would be worth it.
However, investing $210k and only getting an extra $21k in human capital value is a poor return on your investments. Therefore, we’d say $210k is too much college debt for this person.
How much college debt is too much is a complex question to answer.
As I’ve shown above, the best way to answer the question is by examining the impact of college debt and the impact your future income has on the value of your human capital.
By David Hughes and reviewed by Joseph Reinke, CFA