Some financial experts maintain that there is no such thing as good debt. In a sense, they are correct. It’s never ideal to owe money. However, there are some categories of debt that provide discernible benefits to their borrowers, while others are purely detrimental. Student loans possess characteristics of both.

Federal student loans are considered good debt because they are an investment in the student’s future, enabling substantial increases in the student’s earning potential. Federal student loans also carry relatively low fixed interest rates and offer flexible repayment options.

However, for students who plan on entering relatively low-paying careers or take on too much debt, the debt-to-income ratio can be crushing. Missed payments can have a negative effect on graduates’ credit scores and student loan debt cannot be easily erased by declaring bankruptcy. If these factors enter the equation, student loans can quickly become bad debt.

What is Good Debt? What is Bad Debt?

One frequently used example in illustrating good debt is a mortgage. Because repaying a mortgage ultimately ends with the ownership of an asset that appreciates in value — a house — the mortgage debt can be considered good debt.

Conversely, such debts as car loans and credit card balances do not provide much benefit to the debtor. These debts involve consumption, as opposed to investment. The purchased item depreciates in value, leaving the borrower with debt and a possession that has decreased in value.

While student loans don’t directly parallel either example, if properly planned, they can be considered a sound investment. The debtor ends up in possession of an education that accrues value over a lifetime of work.

Will My Student Loans End Up Being Bad Debt?

Assessing whether it is worth taking on student loan debt remains relatively simple

Start by calculating your debt-to-income ratio.

  • Multiply your total first-year student loan debt by the number of years you will be in school. Multiply this by a fudge factor to compensate for interest capitalization and annual increases in student loan limits.
  • Then, use income data based on your academic major to project your anticipated salary. Sources of salary data include the Bureau of Labor Statistics, PayScale.com, Glassdoor.com and Salary.com.

If your estimated debt is greater than a year’s salary, your debt burden is likely unsustainable. Your monthly payments may outstrip your ability to earn and save.

Paying more than 10% to 15% of your income toward student loan debt is a bad idea. This may compel you to take on an extended or income-driven repayment plan, which will extend the time during which you will be paying on the loan and likely the amount of interest you will ultimately pay. Even the income-driven repayment plans, which forgive the balance of your debt at the end of a stipulated period (20 or 25 years), leave you with an obligation to pay income tax on the cancellation of debt. That amount can be substantial.

Should you end up missing a payment on a student loan, your credit score will likely be affected, sometimes by as many as 100 points for a single missed payment. If you miss payments on a private student loan, it may default in just a few short months. Unfortunately, student loan debt can rarely be written off during bankruptcy proceedings, so even that extreme step will not free you of your student loan debt. Your wages and income tax refunds may end up being garnished and offset to compensate the lender.

Will My Student Loans End Up Being Good Debt?

On the other hand, if your projected debt-to-income ratio is favorable, allowing you to comfortably make monthly payments and pay off the debt within say, 10 years, the student loan debt will likely work in your favor. In general, Bachelor’s degree holders earn more than those with just a high school diploma — some 57% more based on data from the National Center for Education Statistics. Master’s and doctorate degree holders earn even more.

The higher earning potential, in addition to the obvious benefits of added financial security, can provide the borrower with an opportunity to build credit by steadily paying off loans. Most college graduates have a thin or non-existent credit history, so regular payments can be extremely helpful in demonstrating credit-worthiness to future lenders.

Further, payers that fall under a certain income threshold ($80,000 for single filers and twice that for married filing jointly) may also be able to write off up to $2,500 in interest a year on their taxes. Public service employees and teachers can apply for loan forgiveness.

A Little Forethought, Major Payoff

Errors in planning can lead to “bad debt” as a result of student loans. However, if you keep your student loan debt in sync with your projected income following graduation, you can rest assured that you will be taking on “good debt” — in addition to reaping the benefits of a college education.

Remember, the more you save for college in advance, the less you’ll need to borrow. College savings plans are the antidote to student loan debt.