The slippery slope: how student debt adds up

Student debt smarts

August 25, 2008

Natasha’s in her last year of college and owes $20,000 in student loans. Her friends (with less debt) are talking about backpacking through Europe after they graduate. Natasha figures “what’s another $5,000 in debt?” and decides to borrow more so she can go too.

What will her decision will cost her down the road? If prime stays at 4.5% and she pays her debt off in five years, here’s what would likely happen:

Interest option	Her monthly payment	The total she will repay
Fixed interest rate	$570.75 (principal and interest)	$30,820.68 ($25,000 principal + $5,820.68 interest)
Floating interest rate	$541.04 (principal and interest)	$29,216.13 ($25,000 principal + $4,216.13 interest)

If Natasha borrows $25,000 and heads off for Europe:

* Results based on the student loan repayment calculator provided by the National Student Loans Service. Assumes interest rates don’t change over 5 years.

Now look at how much less she would have to pay if she put off the trip and just had $20,000 in student loans to pay off. We’ll assume again that prime stays at 4.5% and she pays her debt off in five years:

Interest option	Her monthly payment	The total she will repay
Fixed interest rate	$456.60 (principal and interest)	$24,656.54 ($20,000 principal + $4,656.54 interest)
Floating interest rate	$432.83 (principal and interest)	$23,372.90 ($20,000 principal + $3,372.90 interest)

If Natasha limits her debt to $20,000:

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* Results based on the student loan repayment calculator provided by the National Student Loans Service. Assumes interest rates don’t change over 5 years.

It turns out Natasha will pay an extra $1,000 or so in interest if she borrows the money to pay for the trip – assuming she pays the loan off in five years. If she takes the usual 10 years, the amount of interest could more than double.

So the question Natasha really has to ask herself is this: how fast can she pay off this debt? And is it worth $1,000 or more in interest to get to Paris and Rome now? Or should she wait until she has saved the money and can go interest-free?

Since she doesn’t have a job and will delay getting into the workforce, she’s really taking on a lot of financial risk. Debt has a nasty habit of spiraling out of control, once you take the first step down the slippery slope.

NEXT: Making borrowing make sense: One student’s story

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