Are Student Loans Worth It? Here’s How to Decide How Much College Debt to Take On

If you’re considering a career that requires an expensive program or graduate degree, will the promise of the career and salary make student loans worth it?

As you explore schools and programs, you need to weigh two important financial factors: how much your future earnings will be and how much student debt you’ll need to take on.

If you need to rely on a large amount of federal student loans, you may benefit from thinking about your loans in a new way, one that frames your monthly payment as more of a tax than a traditional loan payment.

Here are some straightforward ways to evaluate whether student loans are worth taking out in your situation.

Is college worth going into debt?

There are many questions you should ask yourself before diving into a future filled with student loan debt:

• Can the degree help give your career a boost?
• Will you find the role fulfilling?
• Will you be able to afford your monthly student loan payments?

Whether you can afford your education costs is perhaps the most important question. And the primary determining factor of whether you’ll be able to pay your student loans off is going to come down to your potential career earnings.

Most of today’s federal student loan plans revolve around how much you earn annually, making student loan payments more affordable all-around. By leveraging the loan rules for income-driven plans, you can maximize your earnings and avoid making common student loan mistakes along the way.

Are student loans good debt or bad debt?

“Good debt” means the pros of taking on the debt greatly outweigh the cons.

For student loans, if your expected income for the first year after graduation is greater than your total student loan debt, your student loans are considered good debt. This general rule also applies for more extensive programs, like medical or dental school.

In this case, you’d look at what your income will be once you’ve finished your residency program or achieved your full, high-earning potential.

Why use this rule of thumb

To pay back a large student loan, you can generally expect to pay 1% of the principal balance each month.

If your income is also greater than your total student loans, then your student loan payments should be less than 10% of your pre-tax income.

For example, let’s say you took out $200,000 in student loans to pay for medical school and you’d leave your residency with a $250,000 salary. Here’s how the numbers would play out for your payments:

• $200,000 (student loan debt) x 1% = $2,000 monthly payment
• $24,000 (12 monthly payments) / $250,000 (salary) = 9.6% of your pre-tax income

In this case, most people can comfortably afford to commit to that level of student loan payment without struggling financially or taking on unnecessary stress.

What to do if your student loan debt is more than your annual income

So what if your income doesn’t outweigh your student loans?

Thanks to the introduction of income-driven repayment plans, many borrowers can take advantage of low monthly payments and eventual loan forgiveness.

With IDR plans, your student loan payments are based on a percentage of your discretionary income rather than only accounting for your balance and interest rate. It essentially becomes a tax on your income for a set period of years.

So, how do you know what’s considered good debt if you need to borrow way more than what you’re going to earn? One option is to to use Public Service Loan Forgiveness (PSLF) to your advantage.

The PSLF program typically uses 10% of your discretionary income to determine what your monthly payment will be, regardless of the size of student loan debt.

You’ll also have any remaining balance forgiven tax-free after you complete the 10-year repayment period.

Let’s say you took out $75,000 in student loans to become a teacher and your annual salary is $60,000 (the average high school teacher earned $60,320 in 2018). Your payment might look like this under PSLF:

Your monthly payment could be lowered from $833 with a traditional loan payment to $344 while pursuing PSLF forgiveness. And the remaining $72,557 balance would be forgiven tax-free once you complete 120 qualifying payments.

The great part is that the monthly payment isn’t going to change if your student loans are significantly more. So, whether you have $75,000 in student loans or $200,000, you’ll only pay based on 10% of your income.

Under PSLF, you’re basically following the same rule of thumb that comes out to 10% of your pre-tax income; therefore, the amount of debt you have doesn’t really matter as long as you stay on track with meeting PSLF qualifications.

Repay loans under an IDR plan

If you plan to work in the private sector, you won’t qualify for PSLF, but you can take advantage of IDR plans like Revised Pay As You Earn (REPAYE), Pay As You Earn (PAYE) and Income-Based Repayment (IBR).

These IDR plans use your discretionary income to calculate your monthly payment, ranging from 10% to 15%.

You’ll also have your remaining balance forgiven after 20-25 years depending on the plan, but you’ll be responsible for a significant tax bomb at the end of the repayment period.

You can prepare for paying off this large tax bill on the forgiven debt by setting aside 5% to 10% of your income annually into mutual funds. That way when it’s time to pay, you’ll have access to immediate funds to cover the cost.

In this example, your student loan tax would be more like 15% to 20% of your income:

Student loan payment (10-15% of income) + tax bomb mutual fund plan (5-10% of income)

So, how do you figure out if the college debt is worth it under an IDR plan?

Ask Me About Your Student Loans

Here’s a quick way to see if student loans are a good idea

Start by taking your expected income after graduation and wiping away 10% to 20%, depending on which repayment plan you’re pursuing.

If your remaining income is still higher than what you’d be making without your desired degree, then taking out the necessary student loans is generally a good decision.

IDR example for dentists

Let’s say your goal is to become a dentist. Because dental school is the most expensive graduate program, you can expect to take out a hefty amount of student loans.

Based on Student Loan Planner® consultations with over 500 dentists, the average student loan debt for dental clients was approximately $385,000.

Meanwhile, the average salary for dentists is $156,240, according to the Bureau of Labor Statistics.

Using these numbers and our free Student Loan Calculator, your expected student loan tax under the different IDR plans would look like this:

Remember, you’ll be combining the monthly payment and the amount set aside in mutual funds to determine your total student loan tax.

For this scenario, you would subtract $1,427 a month from your income under the PAYE plan to decide if your student loans would still be considered good debt.

Are student loans worth it?

Student loans can help you achieve your goals when you go into debt with your eyes wide open.

Keep in mind that your personal interests and skills should also guide your decision. You’re more likely to stick with a field that aligns with your interests.

While the decision isn’t all about finances, you need to be aware of the financial implications of taking on student loan debt. There are many paths that can lead to your future career. But none of them should end in debilitating debt.

By going in with a strategic student loan plan, you can achieve the degree and career you want without signing up for a massive student loan burden.