How Student Loans Work

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[The following is a partial transcript of this episode of The Scott Alan Turner Show. Listen to the full episode to hear this story, listener questions, money hacks, and inspiring stories of people that are changing their financial lives. Subscribe to the free podcast on iTunes or Google Play]

You already know the stories about Bill Gates of Microsoft and Mark Zuckerberg of Facebook – college dropouts that are now so reach they are secretly building cities on the moon so they can escape the Zombie apocalypse.

Realize for many of us normal people, we went to college or have visions of our kids going to college.

A study found on average college graduates earn $1 million more over their lifetime than people who don’t go to college. Another study found the income gap between people with college degrees and high school degrees was $17,500 a year.

You can see by those numbers, education is important. But its also very expensive. When it comes to finances the big two for most people are retirement saving and college planning.

The problem is most people can’t afford to write a check for tuition, even at a small, reasonably priced university.

Part of that college planning is usually student loans. My parents took out student loans for me so I could go to school.

There is a big incentive for parents and kids to take out student loans to pay for college.

Think about what you could do with an extra $1 million in income or an extra $17,500 a year?

That’s a car right there, in your first year of working.

How Loans Work

If you know how loans and interest work, congratulations! You’re going to be able to help others understand the pitfalls and benefits of loans. Listen to this analogy, because you can use this to make the lightbulb go off in someone’s head.

A borrower takes out money to pay for something, and gets charged interest for borrowing the money.

It’s kinda like a snowball rolling down a hill, which gets bigger as it rolls. The amount you borrow is the snowball, and the hill is time and interest. The steeper and longer the hill, the bigger the snowball will get and the more money the borrower has to pay back.

The shorter the time and the less steep the hill – the lower the interest rate – the smaller the snowball gets and the less the borrower has to pay back.

The amount you borrow is always the least amount of what you have to pay back. The question is how big that snowball gets, and how much extra somebody pays back.

How Student Loans Work

Student loans are different than other types of loans because they have fixed interest rates, often at lower costs than other loans like an adjustable rate mortgage. Student loans are easier to get approved and don’t require a good credit score. The catch is borrowers are stuck with them forever until they get paid off.

One of the reasons for the student loan crisis is lenders gave away all this money knowing they were guaranteed to get paid back. Borrowers can’t get rid of student loan debt in a bankruptcy like they can with credit card debt. Lenders gave out money like candy knowing there was zero risk of not getting paid back.

The borrowers got hosed on that deal with the lure of ‘easy’ money for expensive schools.

When it comes to paying back student loans they have some features other types of loans don’t.

The loans aren’t due right after graduation. Often the first payment is due 6–9 months later. The downside is interest is building up when the loans aren’t being paid back. Waiting costs borrowers more.

If there is a situation where the borrower is unemployed the payments can be deferred until later.

Student loan interest is tax-deductible up to certain limits, that’s one of the small benefits.

For some types of employment like working as a teacher for government schools, the loan balance can be waived after 10 years of on time payments.

There are government loans, which come with better interest rates and features, and private student loans, which generally have higher interest rates and cost more over time. A bigger snowball.

Some parents take out private student loans for their kids, called PLUS loans. The parent is on the hook for paying back the loans. With so many people short on retirement savings, PLUS loans are usually a terrible idea. I appreciate parents how love their kids and want to help them succeed. Realize the massive burden those parents are placing on themselves by sacrificing their own retirement. A parent may have twenty years until retirement age to build wealth. A child has 50–60 years to build wealth.

Within all these loans are different types of repayment plans, which people should get educated on before taking out loans. The length of the loan. Some loans start with smaller payments and the payments get bigger over time. Some are based on the borrower’s income when they get out of school.

My advice: Think it through and weight the costs of student loans vs. the potential increased income. College is a big part of people’s lives, and paying for it can be scary and confusing, not to mention if people don’t understand the amounts and how interest works, it can be bad news for both kids and parents.

The #1 reason millennials can’t afford to buy a home is because of student loan debt. Reduce the student loans for college, and people can buy a home that much earlier in life, sometimes as much as ten years sooner.

A top reason parents will retire with so much less than they deserve to have, is paying for college.

College can change a person’s life because of huge debts. But the good news is college can also change a person’s life with increased income.

I have a Bachelor of Science degree. They call that a BS degree. Some BS degrees can pay for themselves, and some BS degrees are exactly what the letters stand for.

I think I kept that very family friendly, what do you think Katie?

Use College Scorecard to compare the cost of the loan to the potential income from the degree so you can get an idea if the degree is worth the cost. Nobody wants to pay $100,000 for a degree in underwater basket weaving that pays $15,000 a year.

That’s like paying $20 for a $10 bill.

But don’t you think everyone wants an extra $1 million.

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