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Manage student debt properly to avoid burden later


If you've ever tried borrowing money from a bank, you might be able to relate to the frustration experienced by one Texan who tried to take out a loan back in April, 1992. The unidentified 40-year-old man caused quite a commotion, according to an Associated Press report.

According to a bank spokesperson, when the man was informed that his loan application was denied, he stripped off his clothes, sat in the vice- president's office, and quacked like a duck.

"It was a first for us," Bank One spokeswoman Diane Vaughan said. When police arrived, the man answered questions by quacking. After his arrest, police said he caused $1,000 damage to a police vehicle by butting his head into a window frame and kicking a door.

Yeah, I tried the same thing a few years back. Borrowing money can be an exercise in frustration -- unless you're a student, it seems. The question is: How much should your child borrow for an education? If you're like many Canadians, the answer will be "as much as he can get his hands on."

But does this really make the most sense? No.
The epidemic

I think of student loans as an epidemic of sorts. In June, 1997, Statistics Canada and Human Resources Development Canada conducted a National Graduates Survey -- the most recent survey of its type in Canada -- where they interviewed 43,000 students who graduated in 1995. The study found that in 1995 graduates owed about 140 per cent more in student debt at graduation (after adjusting for inflation) than the class of 1982.

Those who got a bachelor's degree in 1995 owed, on average, $13,300 when they graduated. Statscan has calculated that by 1998 this figure increased to $25,000 of debt owing at graduation. A big jump from $13,300 just three years before! And no wonder. The cost of tuition increased at an average annual rate of 9 per cent in the 1990s, and is still on the rise.
Rule of tens

How much should the student in your life borrow for an education? There should be a limit. And that limit should be based on your child's likelihood of being able to repay the debt.

Of those who graduated in 1995, 23 per cent who had borrowed for their bachelor's degree were not making loan payments at all two years after graduation. And 16 per cent actually owed more two years later than they did on their graduation day.

The general rule to follow when it comes to borrowing for an education is what I call the Rule of Tens: For every $10,000 of student loans, your child should earn about $10,000 annually over a base income of $10,000 in order to repay that debt in 10 years.

Want an example? Suppose your child graduates with a student loan of $30,000. She ought to earn $30,000 a year plus a base of $10,000, for a total of $40,000 annually, to be able to pay off her student loan in 10 years.

In this example, 11 per cent of your child's gross income will be devoted to loan payments. This may not sound like a lot -- but it is. Check out the table. It shows how much your child should earn in order to pay off his student loan in 10 years, assuming an 8-per-cent interest cost on the loan.
Other ways to pay

There are five ways to pay for an education: Begging (getting free money in the form of scholarships and awards), borrowing (student loans), stealing (where parents steal from their registered retirement savings plans or other assets to help), sweating (your child works while at school), and saving (the easiest way to go; start today and set aside money for education).

If you want to help your child keep a lid on his or her student debt, you've got to focus on the other ways to pay for an education. In particular, devote time and money to saving for that future education of your child. It's the easiest way to go.
Tim Cestnick, CA, CFP, TEP is author of Winning the Tax Game 2002 and Winning the Estate Planning Game. He is managing director, Tax Smart Services, at AIC Ltd.

Required salaries

Based on student debt










-*Monthly loan payment on student debt; interest on loan of 8%; term of loan is 10 years.

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