Ask the Blogger: Borrow Money, or Self-Finance School?

What's the best way to pay for a part-time MBA?

Dear Blogger:

I'm in my first year in the fully-employed (part-time) MBA program at UCLA. Should I self-finance the tuition and stop putting money in my 401K, or should I take out loans and continue to add to my retirement savings instead? The student loan debt will be my only liability. I have $50,000 in savings that I have been accumulating for a downpayment on a house, but intend to rent for the next few years while I'm still in school.

The Loanly MBA

Dear TLM:

You have already made a financially responsible decision by not behaving like I did when I got my MBA. Along with many of my classmates, who entered graduate school at the height of the dotcom boom, I borrowed a great deal of money for tuition and living expenses. We read work on lifecycle consumption smoothing from economists like Kotlikof, and decided to enjoy some really smooth consumption, in the form of nice apartments and vacations. After all, once we graduated, we'd get paid approximately one squillion dollars to apply our incredible MBA expertise to important business problems. So why pinch pennies now?

This triggered a rather indignant response from Kotlikoff himself when I wrote about it for the Atlantic. The gist of his argument was "That's not what I said!" and too true. We were egregiously misreading his work in order to justify an unreasonable amount of consumption. I didn't buy the Hope diamond, or anything. But if you want the names of some great restaurants in Chicago, I am in a position to recommend quite a few.

You, on the other hand, are trying to decide between retirement savings and self-financing your education, both of which are good things. Deciding between the two involves a painful tradeoff. But in the end, you should choose . . . neither.

Don't borrow money, or stop your retirement savings. Cash flow the tuition, dipping into the house fund as necessary.

There are a few reasons I say this. The first is that keeping up retirement savings and tuition, while spending down your house fund, is going to make you very motivated to keep expenses down. That is an excellent mindset with which to approach school, one that too few grad students--particularly professional school students--ever master. Yes, education is an investment in yourself, but there's no reason to overpay for the asset.

Also, as it stands, those savings are earning you approximately zero dollars a year if you have sensibly tucked them into a money market account. (If you have put them in the stock market, they'll earn more, but you're making a big mistake; stocks are too volatile for money you'll need within a few years. You don't want to suddenly have your house downpayment drop 10% in value right as you're ready to start looking.)

It makes little sense to leave money in the bank earning no interest, while borrowing money at 5% or higher. It makes even less sense to leave it there while sacrificing tax-advantaged retirement savings that could be giving you a guaranteed instant return of whatever your tax bracket is. Take that money out of the bank and use it to pay for your education.

But I want to buy a house when I get out of school! I hear you cry. And you should--but not right away. The first couple of years out of school, you may want (or need) to switch jobs and cities. Give yourself a couple of years to settle down before you purchase a house. There are houses on every block. One will be available when you're ready to buy.

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And if your MBA gives you an income boost--and isn't that usually the point?--you shouldn't have much problem replacing the money you took out to pay for school. Treat yourself to one nice thing, then live on your old income until you've padded out your savings account again. You'll find it much easier to save without a monthly loan payment--and much easier to qualify for a good mortgage rate without five-figure student loan debt.