In episode 463, I made this statement:

“If you borrow more than your first year’s annual gross salary, you could be headed for trouble.”

At the time, I literally just pulled that out of the air, but something seemed to make sense about it, though I couldn’t figure out why. So I decided to do the math on it.

Federal student loans like the Stafford loan typically have a 10 year repayment term. Logically, borrowing your first year’s salary in loans means that 10% of your gross pay is effectively ear-marked for student loan payments. Now, gross pay is not net pay. After taxes, social security, Medicare, state and local taxes, your after tax income is typically your federal tax bracket plus about 5%. If you make less than $31,851, you’re in the 15% tax bracket, so 20% after all is said and done. if you make less than $77,100, but more than $31,851, you’re in the 25% tax bracket, or about 30% after all is said and done.

So, how much can you actually afford to borrow in student loans? Assuming you want a quality of life that allows you a certain amount of flexibility and entertainment, I am going to go back and revise my statement from episode 463 to read:

“If you borrow more than your first year’s annual NET salary, you could be headed for trouble.”

Here’s the math. On a $30,000 salary, after taxes your monthly income (net) is roughly $2,000. If you borrow $30,000 in Stafford federal student loans at today’s rate of 6.8%, your monthly payment is roughly estimated at $345 for a 10 year term. That’s a whopping 17.3% of your net income, way above the recommended 8-10%. Even if you consolidate your Stafford loans, you’re still talking about $230/month, or roughly 11.5% of your monthly net income, at least in the first year. As time goes by, you should theoretically earn more each year, and at the end of 10 years, assuming 3% raises and fixed Stafford loan interest rates, you’d be paying about 15% of your net income, 10.1% if you consolidated.

That’s still high.

If you do the math for a $30,000 salary with $24,000 in Stafford federal student loans at 6.8%, the loan payments are much more workable. Your monthly payments would be $276 for regular Stafford loans, $184 if you consolidate, making the payments as a percentage of net income 13.8% and 9.2% respectively. That’s a lot more manageable. At the end of 10 years, you’d be at 12.1% and 8.1% respectively.

Student loan consolidation brings those payments below the 10% of net income, which is where you want them to be. Before you borrow, do the math so that at the end of your college education, you’re not so badly in the hole that your quality of life is miserable. How do you do that? Go to an affordable school, find tons of scholarships, and borrow responsibly – do the math before you sign on the dotted line.