September 17, 2020
My Dear Reader,
In a recent survey by pew research, more and more young people between the ages of 18 and 29 are living at home. The study found that this number steadily rose over the past few months, due to the pandemic in some capacity. However, I believe that there is an underlying issue that has been exacerbated by the pandemic and should cause us to reconsider how we pay for additional schooling.
First of all, I believe that in order to understand the complexity of the student loan crisis, we should understand that debt has many shades. The way that I used to understand debt was very simple. All debt is bad because I am sending money away to a financial institution or bank. I believe that this is the common notion. So the only logical conclusion that can be drawn from that philosophy is: always pay with cash, never use a credit card, and live below your means. This was Matt Love’s thesis in Don’t be Debt Free and Broke.
First, it’s important to know what ugly debt is. Ugly debt has two main characteristics: It has high-interest rates, and it cannot be deducted from your tax bill. A great example of ugly debt is excessive credit card debt. Double-digit, nondeductible interest can sink anyone’s financial situation. I’m not advocating for anyone to chop up their credit cards to “cheat the bank” here, but it is important to note that credit cards have what is called revolving debt. Revolving debt is used with credit cards because a lending institution can quickly approve someone for a line of credit, which the user can then spend on virtually anything that they want. There are two reasons why many people run into trouble with this type of debt. The first reason is that because of the flexibility of that line of credit. Someone could buy many different toys and games without realizing that what they are buying is not going to help them in the future. This means that they are going to have to find additional funds, from their lifestyle or work, to pay it back.
What this creates is a slow spiral that requires more and more cuts to the budget as more and more money is spent on ugly and ever-increasing debt. I don’t disagree with cutting the unnecessary, but very few, if anyone, got rich solely by cutting expenses. This isn’t the only issue caused by revolving debt; the other is the fact that there are no repayment terms. What I mean by this is the fact that unlike a car loan, for instance, that the institution wants you to pay back as quickly as possible, with revolving debt and its interest, there are no discernable repayment terms. There is more than likely a minimum payment, but certainly no table to pay off the debt itself. As I stated before, I am not advocating to get rid of your credit cards, but it is an example of how crippling debt can be. To help remedy this issue, one of the things I do is set a limit on how much I’ll charge on mine in any given month, and simply adjust it to my income that month.
Bad debt is most debt. That line may surprise some, but it is the truth. That is because bad debt is considered to be characterized by: non-deductibility, a variable interest rate, debt that is repaid in installment terms, and in short repayment terms. We’ve already covered what deductible means and what revolving debt is. We must first define and understand what a variable interest rate is before we get into an example of what bad debt is. Variable interest rate is simple: it can change year to year. This type of interest rate is typically found in student loans and an adjustable-rate mortgage. Be sure before taking out any loan that you check the interest rates to use your money more effectively. A way of looking at bad debt can be summed up in one line: taking a loan out to purchase any asset that is depreciating will result in bad debt. This would be something like a car, particularly a new car, which would force the financial institution to give short repayment terms, which greatly increase your opportunity cost.
However, there is such a thing as good debt, and it is the axis on which the entire banking system turns.
Good debt is deductible has low-interest rates, is repaid in installments, and has controllable repayment terms. Matt Love describes good debt: “I can use someone else’s money and pay them back slowly over time while my asset grows in value. Good debt would allow me to borrow for a long period of time and pay it off whenever I choose with no penalties. Good debt allows the ability to stretch the repayment timeline as short or as long as you’d like so you can maintain control.”
A way of looking at good debt is by looking at it as leverage. An example of good debt: If I borrow from an asset that is appreciating in value, to buy an investment that I believe will pay dividends. We avoid opportunity cost completely, by using other people’s money (OPM), and we gain the use of an asset, which provides us with more OPM, which can be used to pay off the original loan.
Knowing this, I asked Matt in my book Smoke and Mirrors how we should classify student debt, he answered by saying that:
“There’s a couple ways to answer it, because not everyone needs to go to school. I have an old saying that you should never let school get in the way of your education. And there’s truth in that saying, but if you take the idea of being a lawyer [it’s reasonable that] we need law school. If you want to be a doctor, you need to go to medical school. [But] if I want to be a business owner and create jobs and spark the economy, you don’t necessarily need school. [We have fallen into the trap that] everyone needs school, but just because it’s popular doesn’t make it right. So, if you’re going to school for early American church history and you rack up$100,000 of debt to get out of school with a degree, and there’s three jobs in the entire country [which] pay $20,000 a year, you are creating a problem. If you go to school for yoga basket weaving, and you go into debt to get that degree, you are creating a problem. And the problem is this: you’re going to school with money that is not yours to get a job that doesn’t exist.”
“Student loans can be both [good and bad]. Here’s when it’s good. Suppose you go to medical school and come out a neurosurgeon and go into $300,000 debt with student loans in your first year. And your first-year income is over $600,000. That’s justifiable. I like that debt because [it] bought you income for the rest of your life. I consider that a good debt if we couldn’t have the debt we would and have the income. There’s a tradeoff. If I know the job exists, I’m confident that I’ll be able to make a higher income, and taking on some debt can be a good thing.”
Based on this simple philosophy, I believe that we can more fully understand the problem. Clearly, not all student debt is bad debt, however, should we be asking eighteen-year-olds to know exactly what they want to do with their degree and to take on hundreds of thousands of dollars of debt as their life begins? Socially, I believe that we should emphasize a period between high school and college in order for young people to gain other life experiences before they buy a degree should they need it for job advancement. Of course, I don’t want to downplay the humanities, but with the cost of college, the need for a practical degree is increased tenfold.
In the end, I think that a lot of the current political frustration among the younger generation can be traced back to the fact that they feel behind. Their parents and grandparents may have started from zero, but our students today start far behind that behind a mountain of bad and ugly debt.
To Your Creation and Potential,