Laura Rowley Money & Happiness

High Anxiety

Over six years of undergraduate and graduate education, Johnsen had taken out $140,000 in student loans, which her grandmother co-signed against her mother's wishes. After Johnsen earned her master's degree from a prestigious arts program at New York University, she assumed she'd make the median salary cited by the school's financial aid counselor -- $65,000. Instead, she couldn't find a position in her field paying more than $30,000.

Johnsen, 26, has both federal and private loans. She put them on forbearance twice, and has now exhausted all the forbearance offered during the life of the obligation. "The interest is capitalized at the end of each forbearance period, so at the end of two years there was an additional $20,000 to $30,000 on top of the loans I took out," she says.

Johnsen recently started a new job as a media assistant at a New York art gallery that pays $35,000 -- or just over $1,800 a month after taxes. On Sept. 1, she begins a 15- to 20-year repayment plan. For the first two years, her payment is $527 a month. "Then it increases to 900-something," she says. "By that time I'm hoping to be able to further myself with the company." She still takes medication for anxiety and depression.

A Subprime Education

It's time to banish the notion that all student loans are "good" debt. These products unquestionably offer the opportunity to boost one's career -- college grads make 60 percent more than those with only a high school diploma. But the changing nature of the private student loan industry -- which in recent years doled out dollars with the enthusiasm of subprime mortgage lenders -- makes it critical for students to assess the risk, and borrow with a realistic idea of future earnings potential. In fact, these loans are worse than subprime mortgages, because they can haunt the borrower for life.

During the 1990s, average student loan debt doubled. Two-thirds of graduates now leave school in the red, with average borrowing of $21,000, according to the Project on Student Debt. Ten percent of graduates from four-year, private, nonprofit institutions had debt of $40,000 or more.

Private loans, which typically carry higher interest rates than federal loans, have grown at an average annual rate of 27 percent in inflation-adjusted dollars since 2000-2001, according to the College Board. Private loans comprised about one-quarter of the student loans made in 2006-2007 -- up from 6 percent a decade earlier.

Risky Business

"Federal loans offer fixed, low-interest rates and a lot of borrower protections in repayment," says Lauren Asher, associate director of the Project on Student Debt. "Private loans have limited consumer protections and variable interest rates that can go very high. It's a little like going to a payday lender -- you're paying a huge amount to get cash, and that can follow you through your whole life. They can be even more risky than credit cards, because private student loans can't be discharged in bankruptcy."

Some 54 percent of students polled in 2004 said they would have borrowed less if they had to do it again -- up from 31 percent in 1991, according to the Project on Student Debt.

While Johnsen is an extreme example, consider what happens to the 10 percent of students who leave four-year private institutions with $40,000 in loans. Let's say the graduate earns the 2006 median income of $46,435 a year -- or $3,382 per month after taxes. I asked Mark Kantrowitz, founder of FinAid, a college information website, to create a few scenarios contrasting public and private loans, paid back over different periods of time.

By the Numbers

The borrower who repays his loans over 10 years will face a monthly bill of $460 to $551, or 13.6 to 16.3 percent of his income. (See the tables below.) The borrower who repays over 25 years will pay $278 to $392 a month, or 8.2 to 11.6 percent of his income. The private-loan borrower who pays back his debt over 25 years will pay nearly twice the amount of the loan in interest.

Note: The federal Stafford loan has a 10-year repayment, but the term can increase to 12 to 30 years if the borrower consolidates and chooses extended repayment. Private student loans tend to have 20- to 25-year terms.

"Ten to 15 percent of income is typically considered affordable," Kantrowitz wrote me in an email. "So $40,000 in debt is within the range of affordability, although one would probably need a 20-year term on a private loan to make it affordable. But do you really want to still be repaying your own education debt when your children are about to enroll in college?"

A Nasty Business

In his recent book "Spend 'til the End : The Revolutionary Guide to Raising Your Living Standard--Today and When You Retire," Boston University economist Laurence Kotlikoff demonstrates that over a lifetime of earnings, a plumber actually ends up with a higher standard of living than a doctor, in part because of the debt used to finance the physician's education.

"The College Board promises you certain median earnings -- which should allow you to pay [loans] over time. But half the people will earn less, because that's the definition of median," Kotlikoff says, adding that the government will garnish the Social Security benefits of borrowers who don't repay federal student loans. "This is like debtor's prison for people. I dearly love higher education, but this is nasty business."

Congress recently addressed some of these issues with new rules that make repayment more manageable. (See my colleague Anya Kamenetz's column and IBRinfo for the details.) And borrowing is expected to decline amid the credit crunch, as private lenders pull back from the student loan market.

Get Smart About Financing

Don't let the extremes of borrowing daunt your educational plans. At in-state, four-year public institutions, tuition, room, and board averaged $13,589 in the 2007-2008 school year, according to the College Board. And the average full-time student at such an institution receives about $3,600 in grants and tax benefits, reducing the cost further.

A good rule of thumb is to not borrow more than your expected starting salary for all four years of your education, says Kantrowitz. "If you borrow less than your starting salary, you should be able to repay the debt in 10 years," he wrote me in an email. "If you borrow more, you'll probably need extended repayment in order to afford the monthly payments. If you borrow more than twice your expected starting salary, you are at very high risk of default."

And if you're a parent, start saving early. Someone with a two-year-old who wants to save half the cost for an in-state, four-year public university should put $171 a month in a 529 college savings plan. That's less than $6 a day. (My calculation uses the $13,589 figure, and assumes an average annual return of 7 percent and college inflation of 5 percent a year. Crunch your own numbers on this savings calculator.)

Go, State!

Moreover, give serious consideration to financial offers from a state school, especially if you plan to attend graduate school. Johnsen racked up $30,000 in undergraduate loans attending a private liberal arts school in the Midwest, even though she could've gone to a public college for free in her home state, based on her 4.2 grade point average.

"I was adamant that I needed to experience something different and get out of state," she says. "When I was an undergrad, I was thinking I have plenty of time; that I didn't have to think about [debt] until I graduated and was out in the world."

Johnsen recently cut her rent in half by moving to Brooklyn with a roommate, but won't consider a higher-paying position outside her industry. "I couldn't handle the idea of not even using the degree I had spent so much money for," she says. "If I could go back, I would have graduated and found a company that would help me pay for a master's degree. The education I received and the connections to art world through [internship] experiences were fantastic. But I'm going to be paying for it for some time."