Caveat Emptor, Caveat Debtor

They are prepared to make a huge investment in themselves without a promise of return. And, as I recall the law, student loans, unlike credit card debt, don’t magically disappear with bankruptcy.

Does GMAC advise member schools to keep tuition increases low?

We have not tried to raise that (topic) with them. We haven’t changed the price of the GMAT – $250 per test – since 2004. And we agreed, even through we were projecting an operating loss this year, that we wouldn’t raise the price until we saw the recovery in the global economy. We had some stronger years in the past, so we’re not eating into our fund balance; but from an operating sense, we agreed to accept the loss in 2011.

An MBA graduate carrying six figures worth of debt isn’t unusual in 2011. Isn’t that debt load unsustainable coming out of some schools?

That’s probably true. But the computation is still being made. I wouldn’t name one school, or any one class of school. The model applies to all schools. You can come out of the schools that tend to have highest expected salaries and you might choose to go into the not for profit or the government sector. You’ll earn less.

If you were to approach that same young person who is contemplating an MBA with an investment opportunity that required a cash contribution of say, $100,000, presumably the investor would look at comparables, evaluate cash flows, look at the company’s track record or its management’s track record. All of this at the very least.

What would you tell MBAs who are about to take on debt to study?

Caveat debtor. The decision to go back to school and to undertake debt to finance that education is not a trivial set of decisions. There is real risk in both the expectations of income on graduation but a compounded risk in the cost of financing.

Yet for many, the only option is to borrow some funds. Personal savings, family or employers may simply not provide the funding needed. If a student is planning to go into debt then the decision is more complex as one has to decide how much debt to take on and what terms are available. Clearly a loan the rate on which is tied to the London InterBank Offered Rate (LIBOR) may become more expensive in the out years if rates drift up. On the other hand, a fixed rate loan, if one can be found, will have a risk premium in the rate charged to protect the lender.

I’d be looking at worst-case scenarios. If interest rates stay down, you don’t need a whole lot of margin on your income to make a difference (paying off the debt)–almost all you’re paying is principle (on the loan). But if you have a floating interest rate, and it jumps up, we’ll see what we saw during the housing bust.

So your advice to MBA hopefuls?

Unless you’ve bought a house, getting your MBA is as large a decision as you’ve ever made financially. You shouldn’t be taking it on trivially.

Say you’re buying a car. The salesman says, ‘this will go from zero to 60 in ten seconds.’ And you’re looking at a dump truck! You’d better test-drive it.

It’s a caveat emptor: Don’t listen to what the salesman is saying, test it against the hard data. What kind of tuition are you really going to charge me? What am I going to pay for housing? Can I get housing on campus?

Then go to the placement data for a school. Ask which employers come to this campus, and what kinds of jobs are they hiring for? That’s critical. Before even considering the compensation they might pay, are they the kind of companies that the applicant would like to join on graduation? They may be geographically undesirable, even if they are great companies. Get the data for the prior cohort on income upon arrival and income upon graduation. Look at all the data, not simply the one outlier who appears in all the commercials for the program. So don’t look at the salary that one guy in private equity got if you’re looking at a school that private equity doesn’t recruit from.

If you haven’t built the right model, it serves you right. A lot of people are using last year’s models when they build their forecast for the current year. Look at how living costs have changed (in 2011): gas in the U.S. is at $4/gallon, instead of $2 or $3. That’s driving up all your utilities and food costs.

The interest rate on loans needs to be considered. For a long time, students were borrowing at close to nothing. What happens when that rate starts to drift? What you may be looking at, for a number of people, is an education bust. Do your homework before you even sign up for a class.

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