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Sunday, December 4, 2011

Chen: Is Law School Worth It? -- The Ratio of Educational Debt to Income

Jim Chen (Dean Louisville), 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. ___  (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.

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:

Chen

http://taxprof.typepad.com/taxprof_blog/2011/12/chen-.html

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Comments

So, since I have >$200,000 in student loans from law school and am applying to jobs that offer less than $40,000 in salary, it is safe to assume that I will never be a homeowner. Or a parent. Or a car owner. Or a consumer. Or anything. Sh*t, I should just move to Costa Rica and be a homeless berry picker or something.

Posted by: Mmm... | Dec 4, 2011 9:02:44 AM

Perhaps Dean Chen is confusing total debt with debt service payments? Perhaps he's confusing "discharging" debt--what happens in bankruptcy when you don't have to pay the debt back--with amortizing or repaying debt? And perhaps he's confusing the risk profile of lenders (creditors) with the payoff to borrowers (equity)?

A borrower can support a lot more debt if the repayment period is longer, or the interest rate is lower, so the monthly payments are lower. $100,000 in student loan debt at 6%, amortized over 30 years is only $600 per month or $7,200 per year. If law school increases a graduate's income by $7,200 per year over the course of their career (after taxes, so maybe $12K per year pre-tax), it's probably worth it.

Do you really mean to tell me that someone needs $100,000+ in income after graduation to afford to go to law school, when the average college graduate makes $52,000 per year?

If that's the case, how does anyone ever afford to study anything other than law or medicine, since those are the only careers--other than finance--in which people routinely make $100,000+? How do any lawyers ever do anything other than work in big firms? Why aren't the bankruptcy courts overflowing with lawyers representing themselves pro-se?

Should everyone drop out of college, since college graduates rarely make more than $60,000 per year in starting salary and college can cost $200,000 over 4 years?

Or should law schools just start teaching more finance classes so that graduates can spot errors in articles like this one?


Posted by: Anon | Dec 4, 2011 6:29:40 PM

Well Anon - from one who is making it in BigLaw (barely):

I see your logic - that if the increase in income is greater than the total annual debt service, then it is marignally better; but you're discounting the psychic value of continuing to have non-dischargeable debt hanging over your head. And anyway, as of when I graduated (and I haven't checked lately, but I assume it is the same now) the maximum repayment schedule is 25 years, so you can't jsut keep extending it forever.

A second thing that you're discounting is the lost value of those three years that one is in law school; that's time at the very beginning of one's career; dollars saved and invested then are worth much more than the same dollars saved later in one's career. For those of us who graduate law school at age 25, our friends have been working and saving for three years while we've been living in relative poverty, incurring further debt. And when we graduate there is often a six-month or one-year employment requirement before we can participate in retirement plans. So yes, I would say it is necessary to earn 100k+ in order to go to law school and expect to live a middle-class lifestyle, absent massive scholarships or loan repayment assistance.

All this is to say: what was the point of your post? The author's point was that people should think through the decision to go to law school, because after it's all said and done, the value is not really always there. Was your intention to suggest that there is value to legal education that the author overlooked, or was it just to flame and point out errors? Did you graduate from law school? If so, when? I would be interested to hear more about your experience, what you learned from it in terms of debt repayment that might be of interest to those considering law school now.

Posted by: BigLaw Associate | Dec 5, 2011 8:04:09 AM

Other life choices are made to justify incurring a significant student loan burden in grad/professional school. We postpone homeownership or buy very modestly, choose not to have kids, and avoid excessive consumerism (control the need for disposable income). There are plenty of us who care far more about making a difference in the public interest than about accumulating personal wealth. Children are not the only way to leave a legacy in this world; doing good works has its own intrinsic rewards.

Posted by: Another Anon | Dec 5, 2011 8:12:47 AM

You're absolutely right about the opportunity cost of lost wages during law school, although many people work part time--or even full time--while attending law school, so it's not a total loss.

Let's make very aggressive assumptions against going to law school. What do you figure someone making $50K per year out of college for 3 years would have saved? Household savings rates are around 5%, so even if our would be law student is saving a very thrifty 10% and getting a fabulous return on his or her investments, we're only talking $20,000 in the bank at the end of three years.

Add that in to the debt and we're only talking $8,700 per year in debt service payments over 30 years. So if you can make $12,000 to $15,000 more per year pre-tax by going to law school, than without going to law school, it's worth it.

FYI, Federal loans can be extended to 30 years.
http://www.staffordloan.com/repayment/forgiveness.php

Posted by: Anon | Dec 5, 2011 8:55:25 AM

This math is fine until the lawyer bubble bursts.

Posted by: Don L | Dec 5, 2011 11:31:12 AM

Kids, when making your initial decision, don't calculate based on a 30 year payback period. Too much can happen in that time. Yikes.

Posted by: oldcurmudgeon | Dec 5, 2011 12:35:11 PM

There is something very wrong with the numbers Anon 11:55 is posting. According to Nick Gillespie at Reason magazine, the average cost of $25,000 worth of student loans at today's rates is $290 a month. If he's right, $150,000 in law school loans requires $1740 a month. By my calculations, that's $20,880 in loan payments a year. That seems to mean you'd have to make about $30K more annually as a lawyer than not as a lawyer simply to survive.

http://reason.com/archives/2011/11/18/3-reasons-we-shouldnt-bail-out-student-l

Posted by: Lowellguy | Dec 5, 2011 1:58:21 PM

I hate to point out the obvious, and perhaps the not-so-politically correct, but if you're a young woman, and you hope to start a family and maybe, just maybe, stay home for a couple of years while your children are babies....well forget about it if you've got school loans.

Posted by: Sonjy | Dec 5, 2011 2:25:13 PM

Lowell Guy 3:35

Gillespie is assuming a 10 year repayment period at 6.8 percent (the current rate for Stafford loans, which is higher than what many students are able to get through other loan programs).

Leaving the somewhat high interest rate aside, the 10 year repayment period is a bad assumption for two reasons:

1. Students can extend federal loans to 30 years--and it costs you zero in fees, and your interest rate doesn't go up one bit. Extending is obviously the right move.

2. What you buy with the student debt--a degree that enables you to earn a lifetime of higher wages--lasts much longer than 10 years.

You should theoretically spread the cost of an asset over the period during which it produces revenue.

If you go straight to law school from undergrad, graduate at the age of 25, and work until social security kicks in, it will last you 40 years.

With a theoretically correct 40 year repayment period, the cost of $120,000 in debt at 6% is only $8,0000 per year. In practice the student will have a 30 year repayment period, so the cost is $8,700 per year.

If you only plan to work for a few years, or want to be public interest lawyer, getting a law degree may not make sense as a financial matter. But if you get a big firm job at $190K to $220K per year (including bonus) for your first few years, you can break even on law school--net of taxes, opportunity costs, higher living expenses, and the time value of money--in about 2 to 3 years.

You can still have kids before you're 30, and if your spouse ever dies or divorces you and you need to go back into the work force, you'll have a law degree and some impressive experience under your belt.

As for Old Crumugeon's suggestion not to think 30 years ahead--if we all thought that way, no one would ever go to school, get married and have kids, buy a house, or do any of the grown up things that involve taking on responsibility and accepting measured risk.

A medical degree is probably a better investment than a law degree, but if you're not cut out to be a doctor and can't live in poverty until you're in your thirties, a law degree is the best educational investment you can make.

Posted by: Anon | Dec 5, 2011 3:55:53 PM

DOUBLE E.s and Chem Majors regularly are making over 100k by the third year of employment before a law grad gets out the door. Techies rule.

Posted by: DON BENTLEY | Dec 5, 2011 4:04:04 PM

1) are people really getting publishing credit for doing some arithmetic? 2) I don't think the dean is confusing anything, but is providing some useful metrics to think about student loan debt. 3) if only students could know what their chances of getting an adequate salary are, except that those numbers are intentionally obscured by the schools

Posted by: Matt | Dec 5, 2011 4:23:07 PM

I'm a pharmacist, and routinely get approached by students looking to enter the profession. Many already have bachelor's degrees (and the accompanying debt) that aren't panning out as desired.

Currently pharmacy colleges are either a three or four year proposition, and out of state or private tuition varies in the $16,000 to $32,000 range. Most new grads I speak to are coming out $100K + in debt.

Starting salaries are anywhere from mid $90K to $120K but are all trending downward (the glut is not yet as bad as lawyers, but that's only a matter of time.) Pharmacist salaries also offer minimal prospects for significant growth, everyone gets paid pretty much what a new grad gets paid.

Based on that table entering pharmacy school now is only a good option for those who do not have debt associated with prior degrees and are able to get in-State or otherwise lower tuition, for all else it is marginal at best.

Posted by: PharmDog | Dec 5, 2011 5:14:59 PM

I've been a rural lawyer for 25 years. Dean Chen's article is spot-on. Do not be misled by the high "average" salary claims from law school administrators. Those statistics, while correct, are based on relatively few high salaries. There are fewer jobs out there. It's a buyers' market and the jobs which are available do not pay enough to service law school debt, undergraduate debt, car payments, insurance and everything else one needs to just exist. Bottom line: Dean Chen's article should be read by every prospective law student. I e-mailed to my daughter to disabuse her of any idea about going to law school when she graduates.

Posted by: R. Sherman | Dec 5, 2011 6:39:55 PM

I'm getting depressed by the consistently bad finance calculations in these threads. The decision to go to law school is an investment decision. with appropriately high hurdle (interest) rates. Anon 11:55 is a good example of poor finance calculations. You need to compare your two decisions - next best alternative (don't go to law school, no more debt incurred, earning potential Y right away), and invest (go to law school, extra debt of x, earning potential Z in 3 years, maybe scholarship reducing the cost to a degree) along with likely probabilities. Anon's calculations of what you could earn with the extra savings isn't the right math for the question. Sad thing is, you'd even have to consider whether going to law school would be a negative in trying to find a non-legal job if you didn't have a law degree required position post graduation. So it would further depress the rate of return.

Even if you are going to law school for social benefit reasons, still do the math. You could be helping the community full time for 3 full years w/o going to law school and without incurring $100K+ in non-dischargeable costs. So is law a 'must have" or simply a "nice to have" for what you want to do. The cost of law school - actual costs plus lost opportunity costs - these days makes a "nice to have" law degree very expensive.

Posted by: SAN | Dec 5, 2011 8:14:40 PM

I didn't realize what bad shape I was in with my loans until my first job right out of law school paid 35k per year. That's less than most of my friends were making first year out of college with a business degree, like mine. I originally thought it would simply be like doctors- they make no money for a couple of years, then their salary increases dramatically. Unfortunately, it has not been that. You also have to consider sustainability in the field- I was unfortunate enough not to not find a permanent or semi permanent law firm home and ended up bouncing from one billing mill to the next. I worked at a law firm all through college and so many of those lawyers said "Don't go to law school. Its not worth the money." I wish I had listened or could find some alternative field to help pay back the absurd amount of loans I took out for law school, on the notion I'd be making 6 figures fast. I didn't and like many of you, I put off all of the things that generally come with a middle class lifestyle- home, family, decent standard of living.

Posted by: Matt | Dec 6, 2011 5:48:43 AM

SAN is correct that outcomes should be probability weighted. For most people with only a B.A. degree--with the possible exception of some engineers or people in finance--the probability of a J.D. not increasing your income by enough to cover your loan payments (on a 30 year extended plan) is slim.

According to U.S. government data for 2010, the 25th percentile of lawyers (the bottom quartile) made more than $75,000 per year. The median lawyer (50th percentile) made almost $113,000 per year. The 75th percentile made over $165,000 per year.

These figures include all lawyers--public interest lawyers, government lawyers, in-house lawyers, as well as those in private practice.

By contrast, the median individual with just a BA degree made around $50,000 to $60,000.

So unless you're a lawyer in the bottom quarter by earnings--and many of the low earners choose to be there voluntarily by going into public service--a law degree almost certainly pays for itself over the course of your career.

Of course, if you're a bottom quarter earning lawyer, you might have been a bottom quarter earning B.A., so even then, the law degree may be worthwhile.

Posted by: Anon | Dec 6, 2011 10:16:59 AM