# An online article recommends that you should never borrow more for college than the amount you expect to earn as your yearly salary. The example given is that if you can expect to earn \$50,000 yearly and have a loan of \$50,000 you can pay it off in ten years paying 10% or \$5,000 of your yearly income.Assuming that your loan interest rate is 6.8%, what is terribly wrong this example? What if the interest rate is 8.5?

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by sweetysiri92

2014-09-12T08:52:56+05:30

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In the example of returning \$5,000 (10% of income) every year is only an informal way of saying. It ignores the interest that is payable on the capital borrowed. This actually means that the interest is not much and can be paid easily from our earnings or savings. One will get into a financial trouble, if this money is not planned for.
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If only \$5,000 is paid every year, then the interest accumulates and will become a huge amount in 10 years.

Accumulated interest at end of 10 yrs = \$ 46,534.50  at 6.8% per annum
Accumulated interest at end of 10 yrs = \$ 63,049.17 at 8.5% per annum
This is much more than the amount borrowed.

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If \$ 50, 000 is borrowed for 10 years then one has to pay back \$50,000 / 10 = \$5,000 as an installment every year (called EMI) and also, the interest accrued on the balance amount still unpaid.

So at the end of 1st year of taking loan, you pay 1/10th capital + interest for \$50,000 at 6.8%,
= \$5,000 + \$3,400 = \$ 8,400
At end of 2nd year you pay 1/10 th capital + interest for \$ 45,000 at 6.8%
= \$ 5,000 + \$3,060 = \$ 8,060
At the end of 3rd year:     \$ 7,720

At the end of 10th year : \$ \$ 5,340

So every year we have to pay more amount than \$5,000

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if the interest rate is 8.5%, then
At the end of 1st year of taking the loan,  you pay \$5000+ \$ 4,250 = \$9,250.
It is substantially larger  than \$ 5,000.