Student Loan Debt: Understanding The Actual Costs

For parents and students preparing for this fall’s college tuition payments, student loans will likely play an important part of their payment strategy. In fact, by some estimates, nearly 70 percent of Americans graduating college in 2019 will have student loan debt.

The scope of this debt and the difficulties young adults face when paying back these student loans is widely reported in the media and debated among many of the political candidates vying for public office. The actual cost of a student loan is less widely understood. Yet this understanding can help young parents plan for their child’s college education and incorporate it into their overall financial planning strategy.

The Impact on Savings

One factor to consider in looking at the true cost of student loans is lost savings. If a young woman graduates at age 22 with a $100,000 in student loan debt and a 10-year payback period, she will have paid back $150,000 by the age 32. It is unlikely she will be able to save and invest any significant amount over this time.

However, if her parents saved enough throughout her childhood so she did not have to borrow for college, by the time she reaches age 32, this same young woman could have invested $100,000. Assuming a 5 percent return, by the time she reaches the age of 74, she will have $1.2 million.

These two very different scenarios point to the impact student loans can have on the financial well-being of young adults. But what about students and their parents who have no choice but to borrow money for an education? There are other types of loans that may make more long-term financial sense.

Borrowing and Payback Strategies

A whole life insurance policy offers an excellent borrowing alternative. Parents who had bought a whole life insurance policy rather than a term policy earlier in their life may have paid more for their policy initially, but the premium paid is a savings and investment vehicle from which they can borrow. The policy’s cash value becomes another form of forced disciplined savings—which can be used for things like college education.

For example, if parents have a whole life insurance policy with a $1 million policy death benefit, and $400,000 in cash value when their child begins college, they may choose to take a $50,000 loan each year for four years. At the end of the four years, the parents will have borrowed $200,000 against the policy. This sum needs to be paid back, but the graduated student can pay back some or all to the parents without interest.

If parents hadn’t planned ahead with a whole life policy, another strategy to help students avoid student loan debt is for parents to take out a Parent Plus loan for some or all of the money needed. They can pay interest every year, so the balance does not become too high before the student graduates.

These strategies can be helpful when planning ahead, but students graduating in 2019 with substantial student debt may have high monthly payments that make it difficult to save. There are other options.

One option is to go to the bank and have student loans on a 10-year payback schedule restructured on a 25-year payback schedule. This lowers monthly payments and the difference can be invested for the future. Of course, this option assumes that the interest rate spread between the loan and the investment makes good economic sense.

While such payback options can lessen the monthly burden for young adults, the best course of action is for parents to start planning early, adopt a disciplined savings strategy that relies on proven investment and use protection vehicles like whole life insurance. This will help the entire family avoid the burden of student debt that is crippling so many college graduates today.

About Richard Wesselt

With over 23 years of dedication to the financial services industry,
Rich brings a wealth of knowledge and experience in helping clients
plan for a secure financial future. As principal of the Wesselt Capital Group, Rich uses a relationship driven, individual-based approach to macro economic planning. Rich has a bachelor's degree in Economics from the Wharton School and is a member of Top of the Table. He holds his FINRA Series 6 Registration. Follow him on Twitter @RichWesselt.