Millions of student loan borrowers are faced with impossible choices. The average student loan balance has grown so significantly that many recent college graduates’ salaries are insufficient to cover these payments as well as a modest standard of living.

A confluence of economic factors including exponential increases in the cost of education, exceptionally high cost of living in urban areas and the precipitous decline in job security have all influenced this crisis.

Taking on student loans without fully understanding the repercussions of student debt has become a risky proposition. As a result, borrowers need an in-depth understanding of personal financial planning concepts to determine how much student debt they can afford.

Financial literacy needs to be instilled in potential borrowers before they sign up for student loans. Otherwise, they put themselves at risk of being saddled with that debt payment for many years following graduation. A lack of basic financial literacy has led to mounting debt for a generation that likely lacks the resources to address it.

A one-to-one correlation

Student loan debt in America stood at $517 billion in 2006. As of 2019, 44 million borrowers collectively owe $1.5 trillion. The average loan balance is $48,560. Additionally, parents agree to be co-signers on an astounding 90 percent of private student loans. As of 2019, one in 10 student loans is in default, a number that would be far higher without income-sensitive repayment plans.

A demand for higher education is unlikely to diminish, which consequently leads to higher tuition costs, especially at for-profit universities. Moreover, with the U.S. government acting as a guarantor on federal student loans, there are few incentives for colleges and universities to keep the cost of higher education in line. These factors have contributed to higher education costs significantly outpacing the rate of inflation over the last several decades, further necessitating the use of student debt to meet these rising costs.

Upon graduation, many young professionals flock to big cities seeking good-paying careers, where many find that the cost of living eats up all of their earnings. As a result, post-graduates resort to less-than-ideal methods to make ends meet, such as working a second job, taking on credit card debt, living with parents or deferring their loans. Before pursuing higher education, student borrowers need to develop realistic plans to pay off their student loans.

In this photo, people walk through the Stanford University campus in California, May 22, 2014. Getty Images/ Justin Sullivan

Parents and students need to do their due diligence and make a concerted effort to determine what they can realistically afford prior to taking on that debt burden. This requires estimating future income, cost of living and monthly loan payments. If the anticipated payments seem unmanageable, it's time to rethink the approach. How can student loans be minimized?

  • Consider working for a year or two prior to entering college.
  • Start at a community college.
  • Attend a commuter school.
  • Apply for scholarships and grants.
  • Attend a less costly institution.
  • Budget carefully while in school.
  • Only borrow what you can afford to pay back.

In prior decades, it was assumed that a degree would ultimately be economically worthwhile. However, in today's reality, parents and students must ask themselves if a degree provides enough value to justify taking on significant student loan debt.

Understanding how student loans work

In addition to creating a realistic budget and estimating future expenses, borrowers need to understand the impact of compound interest. Often, students capitalize the interest on their loans during school and also after graduation if entering a deferment or forbearance plan. Similar to a credit card, interest is charged on the interest in this circumstance, and it can result in a ballooning loan balance, thus making future payments even higher.

Another important factor people often fail to consider is the amortization schedule for student loans. Like a mortgage, the early payments for student loans predominantly go to paying interest. This makes capitalized interest even more devastating. In many cases, borrowers make payments for years, yet still may owe more than they did upon graduation.

Opting for subsidized loans may help because the interest does not accrue during school years. However, there are limits on how much a student can borrow in subsidized loans in any given semester or school year. Unsubsidized loans, where interest accrues during the school years, may not be ideal, but given the significant cost of higher education and federal limits on subsidized loans, they are likely a necessary stopgap for many students.

Finally, it's essential to understand the difference between public and private student loans. Public, commonly referred to as federal loans, have a safety net built into them through the Department of Education's income-based repayment programs. These types of loans provide a measure of protection in case original payment plans go awry or a job loss makes affording the full payment impossible.

Additionally, upon completion of the repayment plan's term, the remaining debt is forgiven. Though these programs might not be optimal because they do result in capitalized interest, they also do not subject students to the consequences that private loans do. In cases of default, private loan borrowers may be subject to collection activity, lawsuits and wage garnishments with less opportunity for loan forgiveness.

The remedy

The Treasury Department recommends that higher learning institutions make financial literacy coursework mandatory, which some universities have already implemented. Indiana University sends students regular updates on their debt and loan status. The school also created a multifaceted financial counseling program. Overall, debt at the university has fallen by 19 percent since the programs began.

These types of programs are a good start, but much more needs to be done. By providing financial literacy programs to parents and students before, during and after college, universities can help reduce the debt burden and default rates. Getting the student loan crisis under control has to be a top priority for all future administrations and increasing financial literacy is the right place to start.

(Patrick Healey is the founder and president of Caliber Financial Partners, a financial planning firm based in Jersey City, New Jersey.)

The article and opinions expressed here are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you consult your accountant, tax, or legal advisor with regard to your individual situation.