Financial Decisions About College Hinder Annie for a Long Time

Annie is Making Money But Has Huge Debts

In the real world, no one makes perfect decisions all the time. Let’s look at a hypothetical 22-year-old new college graduate, Annie, ready to take on the world. Here is a quick recap of choices she has made to date, and what those choices will cost as she steps into “real life”:

Annie's College Decisions

When Annie was in high school and planning for college, she wanted to stay with her friends. They were all going to a private 4-year college. She decided to go to her dream college, join a sorority with her friends, and rack up $100K in student loans.

To celebrate her graduation, she spent $40K on a brand new car at 6% interest. And, she attended one of her sorority sisters' destination weddings as a bridesmaid, and put it on her credit card ($10K at 22%; minimum payment $300/month).

She got a job that brings home $6k per month. She moved into an apartment with a roommate. Here are her monthly obligations to her debt and housing:

• $100k in loans from her dream college at 7% interest. Monthly payment: $900

• $10k credit card debt at 22% interest. Paying $300/month, a bit above the minimum payment, in hopes of paying it off faster.

• $40k for that brand new car she loves with a 6% loan. Monthly cost: $600

• Rents a nice apartment with a roommate. Her share is $1000/month

  
  

Total cost for these line items: $2,800/month

Of course, she has additional expenses, but let's look at the debts and housing for now.

What Annie Did Right

• Completed her college education on time, which kept her expenses down.

• Got a 4-year undergraduate degree that should improve her earning potential.

• Shares her housing to reduce this cost.

  
  

What Annie Did Wrong

Borrowed $10k for the vacation, on a credit card with a very high interest rate. At $300/month, she is not paying it down aggressively enough. Being a bridesmaid at a destination wedding was an entirely optional expense that she could not afford at the time.

She borrowed $40k for a depreciating asset, a new car.

While going to a private college with her friends was fun, she started her career in deep debt. Unfortunately, this decision was made when she was 17 years old, and now the reality has set in.

What Annie Can Do Now About Her Finances

Annie has already made a smart financial move by taking on a roommate, which reduces her monthly rent expenses. While she carries a significant student loan burden, her degree may give her a higher earning potential in the long run. However, her credit card debt is a pressing issue, especially with the high interest rates currently being charged, and paying it down should be a priority.

According to what I teach in my Money Skills Workshops, Annie should be allocating at least 20% of her income toward debt maintenance and savings. Savings are not realistic until she gets out of most of her debt. Here is a calculation of how much of her income should be going toward her substantial debt:

$6,000 monthly income x 20% = $1,200/month

She is obligated to spend $1,200 monthly on student loans and the credit card. So, progress will be slow.

Before she knows it, she might want to buy a house and start a family. Better pay off this debt so she has more choices later.

To accelerate her financial progress, Annie could consider taking on a side gig, such as working as a delivery driver or waiting tables a couple of nights a week. This could provide extra income to tackle her debt more aggressively or boost her savings. Or she could put more of her income toward her debt by eliminating luxuries, vacations, optional items, and expensive choices.

She locked herself into a problem by purchasing that new car. Driving it off the lot made the value plummet immediately. Seven years of paying $600/month will hold her back from savings or having discretionary cash. Better to sell that vehicle, even at a loss, and get something sensible for around $20k.

How Annie's Budget Can Change

A budget is not set in stone forever. As those existing loan balances decrease, Annie might be able to rework her budget. Her income is likely to increase over time, but so could new debt obligations. Budgeting is both an art and a science, and the best time to start practicing is right now.

Financial confidence is key to making prudent choices, and this is what we emphasize in my Money Skills workshops. Please check our website at www.moneyskillswa.com for more class information and to enroll in a workshop series.