Using student loans to fund your education can be a worthy investment. After all, The George Washington University Center On Education and The Workforce found that a bachelor’s degree graduate earns an average of 84% more than a high school graduate, over a lifetime.
Still, when pursuing a higher education to take advantage this potential earning premium, there is a limit to how much student loan debt you take on.
This concept was totally lost on me when I was navigating the complicated process of financial aid and ended up graduating with massive student loan debt.
At the time, I thought any amount of money I borrowed would be worth the investment, but I have now learned that it’s not the case.
To avoid graduating with too much debt, the student loan debt-to-starting salary ratio is a good rule to thumb to use. In this post, I’ll explain what the student loan debt-to-starting salary ratio is and how to use it to estimate the maximum amount student loans you should borrow and how to improve your student loan debt-to-income ratio.
Student Loan Debt-To-Salary Ratio
The interest rate on your student loan is the amount charged on the loan, expressed as an annual percentage of the loan principal balance. You can determine the annual interest rate for your student loan from your loan promissory note.
The Student Loan Debt-To-Salary ratio is a measure of the amount of student loan borrowed for a college education divided by the expected starting salary after graduation.
The student loan debt borrowed should include all the loan funds used for your education. This means Federal and private student loans you and your family financed.
[clickToTweet tweet=”Use the student loan debt-to-salary ratio as a guide to borrower for your education wisely” quote=”Use the student loan debt-to-salary ratio to avoid excessive education debt” theme=”style2″]
Limiting Your Student Loan Debt-to-Salary Ratio
As a rule of thumb, you should limit your student loan debt-to-starting salary ratio to no more than a value of 1.
- Student Loan Debt
This assumes that you will repay your student loan in ten years with payments that make up from 12 to 15 percent of your income and the average of your student loan annual interest rate is no more than 9%.
How to Apply the Ratio To Your Major
If you are preparing for college or you are a current college student you can estimate the starting salary you can expect earn by using tools like the George Washington University Center On Education and The Workforce Economic Value of College Majors Tool or Comparably’s Salary Database.
Once you have an idea of your earning after graduation, then limit the amount you borrow for your education to that starting salary amount
The table below summarizes what the borrowing limit should be, based on the starting salaries for different majors, with data taken from The Economic Value of College Majors. George Washington University Center On Education and The Workforce, 2015.
College Majors, Average Starting Salary and Student Loan Borrowing Limit Based On Debt-to-Salary Ratio = 1
- Social Sciences
- Liberal/Arts, Humanities
Note. The starting salary amounts are listed in 2013 Dollars. Career-focused majors include, industrial arts, consumer services, recreation, communications, journalism, law and public policy, agriculture, and natural resources, per the George Washington University Center On Education and The Workforce, study.
How To Reduce Your Ratio
A student loan debt-to- salary of more than 1 indicates that the earnings, you can expect to make, is out of balance with the amount of debt you took on.
If this is the case, you can improve your student loan debt-to-salary ratio (i.e. decrease the ratio to no more than 1), in at least three ways:
1. Reduce the amount you borrow;
2. Secure a higher salary; or
3. Both 1. And 2.
Related: Apply these steps to conquer your student loan debt
While Option 1 one is only applicable for prospective and current students, increasing your salary (or side income) to improve your student loan debt-to-salary ratio and pay down student loan debt, faster is an option you can use even you’ve taken more student loan debt than you earn in a year.
Did You Graduate With A Student Loan Debt-To-Salary Ratio of More than One?
~ Melisa Boutin