The question now becomes, what is the right mix of debt. Some options include:
1) Federal Direct Loans
2) Private Loans
3) Family Loans
Federal loans are a common option, but they’re expensive. Private banks are an option, but their fixed rates are expensive too. Family loans are great, but not all of us have that luxury (and even those who do, tend to find family loans unreliable or uncomfortable).
What would be great is if there was an option that recognized us prospective, current, and recently graduated MBA students as being pretty solid bets, ambitious individuals on an upward trajectory, and priced loans accordingly. Why hasn’t anyone thought of that?
Enter Alumni-Backed Student Loans
That’s what I thought until I came across alumni-backed student loans. A company at the forefront of this space is CommonBond, a new student loan company with an innovative model, run by people who were in my shoes not too long ago and decided to do something about it. I spoke with them about the issues around student loans and was so impressed with the company that I decided to join them. This blog post was inspired by our initial conversations where I shared my thought process on how to approach the challenge of funding business school.
So whether we’re lucky enough to have family to help us out or not is no longer as important; we have a low-cost, fixed-rate student loan alternative.
All said, I’m taking on debt, and I want to do it thoughtfully. There are a few things I need to think about.
Looking at the debt used to finance an MBA, it’s easy to just write off the amount with a casual “$100,000, $125,000, $150,000, what’s the difference at that point?!” But you got into an MBA program, so you know better. One framework I find helpful to better understand how much debt could be too much debt is the debt-to-income ratio.
Let’s consider a framework taken from the mortgage market where one’s debt-to-income ratio is calculated to determine ability to pay. In order to calculate this ratio we now need to determine our debt (monthly payments) and our income (gross monthly income). To calculate my student loan payments I will initially use the fixed rates on the Federal Direct Loan and Federal Direct Grad PLUS Loan, 6.8% and 7.9%, respectively. To approximate my income, I will use data from the career report of a top MBA program, where the median salary of a graduating MBA student is listed as 120,000.
Is 22.1% high or low? What kind of debt-to-income ratio should I shoot for? To inform this question, I looked at the federal government’s Income Contingent Repayment (ICR) plan, which is available to everyone and caps your monthly payment to a debt-to-discretionary-income ratio of 20%.
It is important to note that while the government’s ICR plan allows you to cap your monthly payment to a certain percentage of your monthly income, the plan also extends the term of your loan from ten years to twenty five years. This means that you may pay much more interest over the life of the loan than you would have with a standard ten year repayment plan.