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Report: Affordable Higher Education
Big Loans, Bigger Problems
Higher education is critical to our society. In addition to providing the social benefits of an educated citizenry, education is essential for economic growth. As the economy becomes more technology-based, higher education becomes increasingly important for economic success, both for the individual and the nation. Neither an individual nor society can make a better investment in the future than a college education.
At the same time that we demand a college education, most students have little option but to take out loans to pay for it. Grants are not keeping pace with the rising cost of higher education, and students are becoming increasingly dependent on loans to pay for college. Students who make the important investment in higher education are graduating with alarming levels of debt.
In just the last decade, the amount of money borrowed in the form of Stafford loans has more than doubled, from $15 billion in 1992-93 to $35 billion in 1999-2000. 1 From 1992-93 to 1998-99, the average annual loan increased from $3,186 to $4,994. 2 3 The impact on students has been larger and larger debts at graduation. In 1995-96, the average debt of students graduating from public four-year schools was $11,950 and that for students graduating from private four-year schools was $14,290. 4
Students frequently experience “sticker shock” when at graduation when they find out their debt is much larger than they planned or expected. If they do not understand loan repayment and loan costs, they may borrow more than they can afford and experience difficulty repaying their loans. The results can be altered career choices, restricted economic participation, or default. With increasing levels of borrowing, the pitfalls of debt are becoming even more significant.
In this report, we decided to study debt from the students’ perspective to determine if students clearly understand the implications of borrowing. As they leave college, recent graduates are left to deal with the decisions they made as a student. This report examined how much students understand about their loans so that when they graduate they are prepared to repay their debt.
The report analyzed students’ understanding of their own student loan debt. It analyzed students’ understanding of interest accrual and ability to plan for repayment and borrow accordingly.
- Students are not aware of the total cost of their student loans. About 78% of students surveyed underestimated the total cost of their loans, by $4,846. Most students take out loans without a clear understanding of their total cost.
- Larger debt comes with lower awareness of the implications of loan debt. Even with higher expected incomes, respondents with larger debts more significantly overestimated the percentage of their income they could afford to contribute to repayment. Among respondents with less than $15,000 in debt, 36% expect to dedicate more than the recommended percentage of their expected income to loan repayment, compared to 57% for respondents with debts over $30,000. Students with higher levels of debt are already vulnerable to difficulties after graduation; evidence suggests that they are even more vulnerable than they realize.
- Students in their first years of college are at greatest risk. Students in their first years of college were more likely than those in their later years to underestimate the impact of interest. Of students in their first and second years, 84% underestimated the total cost of their loans, compared to 72% of students in their third and fourth years. Students in their first years of college have less understanding of student loan interest and repayment.
We studied four areas to determine students’ understanding of their loan debt and ability to plan for repayment. We looked at the students’ comprehension of the impact of interest, their ability to estimate their future income and borrow accordingly, and their knowledge of repayment options.
Impact of Interest
Interest is a main component of loan repayment, adding a substantial amount to the principle. However, students generally are not aware of the impact of interest. Among all respondents, 78% underestimated the total cost of their loans, by an average of $4,846. Students with more debt were more likely to underestimate the impact of interest, and to underestimate the cost more significantly. Respondents with less than $15,000 in debt underestimated the total cost of their debt by $1,387, compared to $7,189 for students with more than $30,000 in debt. Students in their first few years of college were also more likely to underestimate the total cost of their loans, and by a more substantial amount, than those in the later years of college. While 72% of students in their third and fourth years underestimated the impact of interest, 84% of students in their first and second years underestimated the impact of interest on the total cost of their loans.
One factor of responsible borrowing is the ability to estimate future income. In general, students overestimate their expected income. Whereas the average income for recent college graduates is $27,000, students reported an average expected income of $39,016. Students in their first two years of college, with an average expected income of $39,856, reported higher future incomes than students in their second two years of college, who expected an average income of $38,096.
The loan industry recommends that graduates in repayment dedicate no more than 8% of their income to student loan repayment. However, respondents expected to contribute an average of 10.7% of their future income. Students with more debt were more likely to overestimate the percentage of their expected income they could afford to contribute to repayment. Of students with less than $15,000 in debt, 36% expected higher burden than the recommended amount, compared to 57% among students with more than $30,000 in debt. Students in the early years of college were also more likely to report expected monthly payments of more than 8% of their income and expected higher monthly payments as a percentage of monthly income than those in the later years of college. While students in their third and fourth years in college estimated the percent of income they could dedicate to repayment as 9.5%, those in their first and second years estimated their burden as 11.7% of their income.
Repayment options help students that suffer hardship and graduate with high monthly payments in relation to their income repay their loans without going into default. Most respondents were not aware of repayment options, such as deferment, forbearance, and income-contingent repayment.
Conclusions and Policy Recommendations
We found that students do not have a clear concept of the implications of loans that they take out to pay for college. Students that are most vulnerable, those with high levels of debt, have the least understanding of repayment. This is of particular concern because we know that low-income students are more likely to have greater debt. Also, students in the first years of college have less understanding of repayment than those in later years of college.
While increased consumer education is important and will be helpful, it would be incorrect to assume that this will be the solution to rising levels of debt.
In the face of increasing need, it is tempting to turn to loans. However, evidence suggests that students, particularly first- and second-year low-income students, are not prepared to take on more debt. Students are now borrowing without a clear understanding of loan repayment, and as debt increases, this problem will only compound. We should not propose a solution to unmet need that will increase the burden of student debt. We are concerned with efforts to increase loan limits without reducing the total cost of borrowing for students. In order to help prevent students from going further into debt, Congress should make more grant aid available, make loans more affordable to students, maintain flexible repayment plans, and improve financial and student loan education.
1 The College Board. Trends in Student Aid (Washington DC: 2000).
2 American Council on Education. Facts in Brief: More Undergraduates Are Securing Loans to Pay for Postsecondary Expenses. Vol. 38, No. 15 (Washington DC: 1999). Analysis of National Center for Education Statistics. Trends in Student Borrowing. (Washington DC: 1999)
3 The College Board. Trends in Student Aid 2000.
4 American Council on Education. ACE Policy Brief: New Information on Student Borrowing. (Washington DC: 1997). Analysis of U.S. Department of Education, National Center for Educational Statistics, National Postsecondary Student Aid Study: 1995-1996.
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