A student goes into a bank. He tells the personal loan banker, “I want to borrow $7,500 per year for the next four or five years.”
“That’s at least $30,000 over time,” the banker says. “Personal loans have a 10 percent interest factor.”
“For my loan,” says the student, “I need an interest rate close to a home mortgage, like 6 percent. Also, I don’t want to be charged interest for the first four or five years of the loan.”
The banker asks, “How long will this loan be for?”
“A twenty-year payoff after graduation or shorter,” replies the student.
The banker asks, “Do you have any collateral assets to secure the loan?”
The student says, “No collateral, but I promise to pay it off when I get a job.”
The banker is incredulous. “Anything else you want to tell me about your plans?”
“Yes,” the student says, “there is a 10 percent chance that I will totally default in the first year and a 30 percent chance that I won’t finish my degree. And I may default a few times paying off my loan.”
The banker looks ready to pass out.
The student is not finished. “In case of low earnings, I want you to adjust the new payment amount to 5 percent of my disposable income. If I miss a payment, you won’t compound the interest either.”
The banker is unable to speak for a moment. Finally recovering his voice, he says, “What do you mean by disposable income?”
“Oh, it’s simple,” replies the student. “I subtract $2,200 from my monthly salary, and then I pay 5 percent of what is left.” The student pauses. “And if I qualify and pay for twenty years, I want a loan forgiveness option on the balance.”
The banker is weak, but asks, “Anything else you want for this loan?”
“Well, I may not be able to get a job that has a first-year salary more than my total student loan.”
The banker asks, “The university approved your application based on good grades and test scores, right?”
The student looks condescending, “No, it’s all open admission.”
The banker further inquires, “What will your degree be in?”
“I’ll know more for sure after two years.” The student admits, “I need to find my passion. Of course, there’s a 50 percent chance my job won’t be in my major, and I may be underemployed.”
The banker is mentally exhausted, looking at the clock, wishing for the first time today that someone would telephone so he can cut the discussion short.
“Why did you come to our bank?” The banker adds, “You will never pay this loan off with those terms.”
The student replies, “I wanted to see who had the best rates for a student loan, and if I go through a bank, I might get a new credit card as well; my current one is maxed.”
“So,” the banker says, “I can’t waive compounding interest on your $30,000 loan. The payoff amount will be $35,000 or more by the time you graduate. Even at a 6 percent rate, you have twenty years of payments at $250 a month. If you only pay 5 percent of your disposable income, you will need to be earning more than $5,000 a month to ever pay it off. Where will the bank get the money to satisfy the remaining balance?”
The student nods, thinks, and then says, “That’s great. Let’s sign!”
But the banker says, “I cannot loan you a dime; you’ll need to use federal student loans.”