11 Financial Educators Association The Real Cost of Student Loans: Before-tax Thinking in an After-tax World Jeff Hill and Bryan Sudweeks September 27, 2016

2 Abstract Perspective is important in managing our finances. Too often, borrowers consider only the after-tax amount borrowed plus interest as the amount they must earn to repay their student and other loans. However, if borrowers consider the pre-tax costs of what they must earn, they will make better decisions. This includes federal, state, and local taxes, as well as savings and other charitable contribution goals. The authors present a pre- tax framework to help borrowers understand not only how much they must pay back in principle and interest, but including their other costs as well. While the same pre- tax costs will be paid whether the money is saved or borrowed, borrowers should consider the pre-tax costs in determining whether to take out student or other loans.

33 Purpose A student commented: You taught be about personal finance, but you didn’t teach me how hard it would be to pay back student loans Why is it so hard to pay back? Could it be that our perspective is faulty?

44 Background (continued) We live in a world dominated by after-tax thinking We really should be taking a before-tax approach We will make better decisions when we consider the before-tax cost of purchases and loans We will have more correct information when we consider the pre-tax costs Moreover, we need to be teaching this to our students

55 Background I teach personal finance and asset management at a large private university I was an asset manager (investing in emerging markets) in a previous life I help students put together a Personal Financial Plan to help them over their entire financial lives ( I tell them I will save them $1 million if they follow what I teach) I see the challenges that this after-tax viewpoint has on families This needs to change

66 Article Use The article was meant as a springboard to good discussions Did you ever notice that students talk about salary on an before-tax basis (i.e., $50,000) and borrowing a student loan which is on an after-tax basis (i.e., $3,000) They are not consistent in their thinking It should be after-tax salary and after-tax cost of loans, or before-tax salary and before-tax cost of loans

77 Excel Tool We created a simple spreadsheet to help in this perspective Purpose To help students and others take this before-tax perspective Notice that this doesn’t yet account for interest Location It is available at Helping Others, Learning Tools, and LT 34 Amount to Pay Back.xlsxwww.personalfinance.byu.edu

88 Example Chandler is in the 15% Federal marginal tax bracket and the 7% state tax bracket Assume he is paying off a 6.8% student loan for $3,500, how much will he have to earn on a pre-tax basis For every dollar to pay back, he must earn 1/(1 – ( ) or $1.28

99 Check on Amounts Needed

10 What About Student Loans What about for a $3,500 student loan?

11 Charities and Savings What about for charitable donations and savings? What impact does that have?

12 Subsidized Student Loans What about subsidized student loans? Does this tool handle those?

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14 Multiple Student Loans Notice that the Annual Percentage Rate (APR) changes depending on this perspective A after-tax 6.8% APR loan for a person in the 15% federal and 7% state marginal tax brackets is not 6.8% pre-tax: rather, it has a pre-tax APR of 17.8%

15 Summary We need to help our students have a consistent framework It should either be pre-tax or after-tax However, when we are not consistent in our thinking it brings out problems in our analysis Pre-tax: We correctly state our income but understate our expenses Post-tax: We overstate our income and we correctly state our expenses

16 Implications 1. Borrowers should be careful to use this pre- tax perspective. They should ensure that the salary from their desired job after graduation is sufficiently high enough to pay back their loans 2. Borrowers should be careful not to confuse after-tax and pre-tax amounts, and should be wise in their use of student loan debt 3. Borrowers should look at the total amount they must earn to pay down their debt, their pre- tax amount when considering loans

17 Implications (continued) 4. Borrowers should consider their pre-tax perspective and be wise in their use of student loan debt 5. If governments are truly concerned about student loan debt, this information on the pre- tax costs of loans should be taught more widely 6. If governments truly want to help reduce the burdens on students, reducing Federal and State taxes is a great way to begin