The start of the university year sees thousands of eager school leavers leaving the safety and comfort of the family home and beginning their journey towards independent living. For parents and students alike, the dilemma of how to fund academic pursuits is not an easy one to resolve. Taking on debt is something that most prudent money managers avoid. There are, however, two categories of debt; ‘good debt’ and ‘bad debt’. The question is, in which category do student loans belong?
Putting it simply, bad debt is debt which is usually incurred to buy things that do not produce an investment return such as cars and holidays. Good debt is money which is borrowed to buy assets which produce a return such as an investment property or a business. Whether student debt is good or bad depends on how the money is used. Study is an investment that provides a future return. The best return will be gained from a qualification that will lead to higher levels of future income. The lowest return will be gained from qualifications with poor employment prospects or from having a great time partying but failing to get a qualification at all.
Student loans are repaid by way of an additional deduction from income once the student starts working. In effect, a student loan is simply an obligation to pay a higher rate of tax for a period of time and in that way is different from a personal loan.
What should parents do? Leave your money in the bank for as long as your child’s loan is interest free. Encourage your children to live as frugally as possible to keep borrowing to a minimum and to take courses of study that will lead to better income prospects. That way, only good debt will be incurred.