If you have a rising college student in the house, this spring is an exciting time for your family. Many colleges are sending out information about financial aid and awards, so it’s time to make final decisions about where students will spend their college years—and how families will pay for it.
At one point, common wisdom said that student debt was a form of “good debt” and an investment in your future. But some parents who are still paying off their own debt while considering their child’s college plan may disagree. Now is a great time to evaluate your options to balance a rewarding education with a strong financial foundation.
What Makes Student Debt “Good Debt”
Unlike forms of "bad debt" like auto loans and credit cards, common financial advice has often put student debt into the “good debt” category. Like the other major form of good debt, mortgages, student debt pays for something that doesn’t typically lose value over time. A homeowner may expect their home to appreciate in value, and a student expects their college degree to provide them with valuable knowledge and expanded professional opportunities.
Student loan debt can also have a positive impact on your credit score because your payment history appears on your credit report. By making payments on time, college graduates will build creditworthiness (payment history makes up about 35% of your credit score, so timely—or late—payments can have a big impact).
What Makes Student Debt “Bad Debt”
Even if you are borrowing money for a good reason, such as to finance higher education, debt is ultimately still a financial burden. Parents of incoming college students may know this well. Over 14 million student loan borrowers aged 35-49, and 6.2 million borrowers aged 50-61, carry an average balance of $42,000 for their own college education. Decades of paying off their own debt can leave parents understandably uneasy about encouraging their children to take out loans—or shouldering more debt themselves.
In many cases, student loan interest becomes a big part of the burden. Federal student loans often set lower interest rates for undergraduate, graduate, and professional students than for their parents. So, an undergrad student taking out a subsidized loan may have a 4.53% interest rate, but their parents may face 7-8.5% interest for some Direct or Federal PLUS loans. Private loans may carry even higher interest rates. (At the moment, coronavirus relief includes a moratorium on federal student loan interest, but as of now, it ends on September 30, 2021.)
Many student loans accrue interest from the moment they’re opened, meaning interest adds up during college years and periods of deferment. With subsidized loans, the U.S. government pays interest accrued during student years, 6 months after graduation, and in deferment periods. Unsubsidized and private student loans don’t carry this benefit. Accrued interest can end up being capitalized, or added to your principal balance, so new interest payments are based on the original loan amount plus the accrued interest. This can lead to interest accumulating much faster than borrowers expected, making it hard to get over the interest hump and make a meaningful dent in the principal balance.
Finally, student debt is notoriously difficult to discharge, even in bankruptcy. Some politicians, including President Joe Biden, have discussed student debt cancellation as a priority, but it’s unclear when any such measure may pass or how much student debt forgiveness will be available. Any future student loan forgiveness programs may also only apply to federal loans, leaving borrowers with private loan debt to deal with repayment on their own.