A Degree of Practical Wisdom: The Ratio of Educational Debt to Income as a Basic Measurement of Law School Graduates’ Economic Viability
Jim Chen, A Degree of Practical Wisdom: The Ratio of Educational Debt to Income as a Basic Measurement of Law School Graduates’ Economic Viability, 38 Wm. Mitchell L. Rev. (forthcoming 2012):
This article evaluates the economic viability of a student’s decision to borrow money in order to attend law school. For individuals, firms, and entire nations, the ratio of debt to income serves as a measure of economic stability. The ease with which a student can carry and retire educational debt after graduation may be the simplest measure of educational return on investment.Available for download on SSRN at http://ssrn.com/abstract=1967266. Highlighted by Paul Caron on Tax Law Prof Blog, by Karen Sloan in the National Law Journal, by Sam Favate on the Wall Street Journal's Law Blog, by Debra Cassens Weiss in the ABA Journal, and by the Ed Clinton Law Firm Blog. Paul Caron has kindly written a follow-up post.
Mortgage lenders evaluate prospective borrowers' debt-to-income ratios. The spread between the front-end and back-end ratios in mortgage lending provides a basis for extrapolating the maximum amount of educational debt that a student should incur. Any student whose debt service exceeds the maximum permissible spread between mortgage lenders' front-end and back-end ratios will not be able to buy a house on credit.
These measures of affordability suggest that the maximum educational back-end ratio (EBER) should fall in a range between 8 and 12 percent of monthly gross income. Four percent would be even better. Other metrics of economic viability in servicing educational debt suggest that the ratio of total educational debt to annual income (EDAI) should range from an ideal 0.5 to a marginal 1.5.
EBER and EDAI are mathematically related ways of measuring the same thing: a student's ability to discharge educational debt through enhanced earnings. This article offers guidance on the use of these debt-to-income ratios to assess the economic viability of students who borrow money in order to attend law school.
To offer good financial viability, defined as a ratio of education debt to annual income no greater than 0.5, post-law school salary must exceed annual tuition by a factor of 6 to 1. Adequate financial viability is realized when annual salary matches or exceeds three years of law school tuition. A marginal, arguably minimally acceptable level of financial viability requires a salary that is equal to two years’ tuition. The following table compares some tuition benchmarks with the salary needed to ensure the good, adequate, and marginal levels of financial viability identified in this article:
Tuition Salary needed for good viability Salary needed for adequate viability Salary needed for marginal viability $16,000 $96,000 $48,000 $32,000 $32,000 $192,000 $96,000 $64,000 $48,000 $288,000 $144,000 $96,000
2 Comments:
regarding the one approach that educational borrowing should be capped at 1x annual salary, I didn't see any mention that a standard real estate rule of thumb is that you can afford a home that is 3x your annual salary (some conservative lenders now say you should buy as little as 1.5x annual salary, while during the subprime mess banks would do as high as 4x). That is probably justified by the nature of real estate as a non-wasting asset (unlike consumer items)and the long term nature of the borrowing. If a professional degree is looked at as a long-term asset, rather than categorized with consumer goods and automobiles, then the 3x ratio seems more appropriate than 0.5-1x. The fiannced cost of education will still cut into the amount available to buy a house (banks will still cap the total borrowings at 36%-43%), but in many regions a median-performing student can fully finance both a decent house and 3 years of private/out of state law school within the 3x salary norm. Should they? That is an individual choice that should be made only with full information and real consideration of the trade-offs. I doubt most students have the former, or do the latter.
Re: Anonymous
The difference between a 1x multiple and a 3x multiple is likely the timeframe in which the debt is paid off. Unless a law student wants to pay off loans over 30 years (instead of 10) it makes much more sense to stick with a conservative 1x multiple.
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