college graduate throwing cap in the air

Is College Debt Good or Bad Debt?

The surprising economic effects of student loans

College loan debt is strangling many young people in America. There’s no debate about this.

The staggering student debt numbers

Back in 2013, the U.S. News & World Report reported, “In its ninth annual report on student loan debt, TICAS found nearly 7 in 10 graduating seniors in 2013—69 percent—left school with an average of $28,400 in student loan debt, an increase of 2 percent from 2012.”

These were astonishing numbers. All said and done, in 2012, the Wall Street Journal wrote that student loan debt eclipsed $1 trillion for the first time.

Today, things are only worse. As USA Today reports, “It was big news when outstanding student loan debt surpassed credit card debt and then later exceeded $1 trillion for the first time. That shocking statistic keeps climbing, with no sign of slowing down: Americans now have more than $1.4 trillion in unpaid education debt, according to the Federal Reserve.”

And the average student debt burden today? $30,100.

In the US, the student loan debt crisis is not going away. It’s only getting bigger. And that has big implications for our economy.

Where is all the money going?

Perhaps you’re slightly shocked by the growth of student debt, but maybe you’re also thinking at least it’s going toward a good college education. That’s a good thing, right?

Well, aside from the fact that many graduates don’t think their degree was worth the debt, the reality is that a lot of student loan money doesn’t even go towards an education.

As I wrote a while back (“The Scary Thing College Kids are Doing with Money”):

According to the "USA Today", "About half of students blow some of their school loan money on non-educational expenses, including 3% who spent it on alcohol and drugs, according to a new Student Loan Hero survey."

You read that right. Nearly 50 percent of college kids take out student loan money in order to spend it on things like:

  • Vacations (3%)
  • Restaurants (13%)
  • Clothes (15%)
  • Car Expenses (19%)
  • Monthly expenses like mobile phones (41%)

As Andrew Josuweit, CEO of Student Loan Help, tells "USA Today", "I think they're justifying it because of future income. They're thinking, 'This is the cost of doing business, this is my overhead.'"

In other words, this is free money.

It’s mentality that money is free that leads to statements like these by debt-ridden graduates:

“I once believed that part of the American Dream was to earn a college education and this would ensure a great career and financial freedom. Unfortunately I am losing hope. I'm a mother of three, and my husband and I have been turned down from purchasing a home due to our income-to-debt ratio.”

“My debt is a life-swallowing, all-consuming, hole in my life. No college degree is worth that.”

“My life revolves around work. I'm barely able to afford rent, I'm cutting back on bills and I'm barely able to feed myself. Why? Because almost half my monthly income goes to Sallie Mae.”

Hear no evil; see no evil

Unfortunately, the student debt problem is an easy one for many to ignore. After all, if you weren’t silly enough to rack up huge amounts of student debt, it has no bearing on you, right?

Turns out that’s not entirely true.

According to the Wall Street Journal:

The higher the student-loan debt in an area, the lower the net creation of very small businesses, says a report from the Federal Reserve Bank of Philadelphia, using data culled from the Census Bureau and Equifax consumer-credit statistics.

In the study, published last year, researchers looked at student debt across the U.S. by ZIP Code and compared it with small-business formation in those areas. Between 2000 and 2010, a one-standard-deviation increase in student debt in a ZIP Code led to an average 25% reduction in the number of very small businesses, those with one to five employees.

The conclusion, the researchers believe, is that prospective entrepreneurs are so burdened with student debt that they simply can’t take on any more debt to start a business.

Perhaps you’re thinking, again, what does this have to do with you?

A ticking small-business time bomb?

Small businesses are the heart of the American economy, making 65 percent of the net new jobs over the last fifteen years according to the SBA Office of Advocacy. Now imagine what will happen to our economy if the rate of new small business creation drops as dramatically as the rate at which student loan debt has increased.

This goes to show that when it comes to economies, things are rarely self-contained and that systemic issues can come from anywhere—and they usually start with financial ignorance.

In light of this, you can begin to see why President Trump believes that tax relief for small businesses is so important.

In this case, the ignorance is regarding debt. The conventional financial wisdom is that college debt is good debt because higher education is important for getting ahead. But how’s that working out for our nation’s graduates? Not that well.

The difference between good debt and bad debt

One of the fundamental principles of Rich Dad is understanding the difference between good debt and bad debt. In my opinion, college debt is bad debt.

A financially sophisticated person understands good debt, good expenses, and good liabilities.

I remember rich dad asking me as a young man, “How many rental houses can you afford to own where you lose $100 per month?”

“Not too many,” I answered.

Then he asked me, “How many rental houses can you afford to own where you earn $100 per month?”

The answer to that question was and is, “As many as I can find!”

This simple example illustrates the difference between good debt and bad debt. In each case, I would have bought the houses with a loan, but in one case that loan and associated expenses outweighed my cash flow income. In the other, it didn’t.

The simple definition of good debt is that it puts money in my pocket. The simple definition of bad debt is it takes money out.

So, a simple question for those thinking of taking on more student loan debt: Is it really putting money in your pocket?

The answer, unfortunately and all too often, is no.

Original publish date: May 02, 2017