Currently, 45 million American adults hold a total of $1.56 trillion in student debt. These student loans can take a heavy toll on household finances: they can prevent people from buying cars, taking out mortgages, and qualifying for other loans. This, along with the COVID-19-induced economic crisis, has led many politicians of late to propose some degree of universal student loan forgiveness.
But how do student loans work? Who tends to end up with the most debt? And should our government really do something about it?
There are a few different ways to take out and pay back federal student loans, but the basic process looks the same. Before entering college, a student and their parents will fill out a Free Application for Federal Student Aid (FAFSA) form, which sets out their financial information.
Students send their FAFSAs to prospective colleges. College administrators will review and return the information detailing how much money the student will receive in financial aid from the school. The money not provided by the school is taken out as a loan, which will be paid back later with interest to the federal government.
A common type of student loan is the direct subsidized loan, where monthly repayments begin six months after graduation—but it is only one form of many.
Students can also take out private loans from banks or other lenders instead of using federal loans. These usually have higher interest rates, and payments begin while the student is still in school.
Repayment usually takes 10-30 years, depending on the payment plan. If the debtor defaults by missing too many payments, he or she can be taken to court, become ineligible for other loans, or suffer a host of other consequences.
Despite the high cost of a college education and its potential risks, people are still paying for degrees they can’t afford. “Students are willing to pay,” says Dr. James West, professor of economics at Baylor, “because they’re buying a higher salary for the rest of their lifetime.”
The value of a college degree does not just lie in the skills or knowledge acquired from it. “Getting a college education is seen as valuable because it sends a signal to employers that they can observe: your aptitude, your patience, your ability to do hard work,” West says. “Everyone claims to be a high-ability, high-productivity worker. But it’s expensive and difficult for employers to figure out who really is and who isn’t. The way they do it is by observing a degree,” he said.
Given this reality, it is no wonder that the demand for college degrees—and their price tags—are so high. But the problem of massive student loans is exacerbated by universities’ loan behavior. “The whole financial aid enterprise is an attempt to extract from people their maximum willingness to pay,” says West. Requesting detailed financial information allows colleges to tailor their prices to students rather than having a static tuition price.
Furthermore, colleges do not have to worry about whether students can pay for their high prices because they are not the ones loaning out money—the government is. “Colleges are extracting your maximum willingness to pay…and then the federal government is guaranteeing student debt. It’s just a train wreck,” West says.
Fortunately, there are income-driven repayment (IDR) plans designed to help people pay off their student loan debts by limiting monthly payments based on the borrower’s discretionary income. Discretionary income is essentially the amount of after-tax income left for spending on non-necessities like rent and food. About 9 million borrowers are enrolled in IDRs.
Even if students can afford monthly payments, they can take a toll. “If students accumulate lots of debt, it makes it more difficult for them to buy cars, qualify for mortgages, and make down payments,” says West.
Surprisingly, the 3% of adults with doctorate degrees own 20% of the outstanding debt—but they also make more than twice the national median earnings. 56% of our country’s student loans belong to those with graduate degrees.
At the same time, 52% of defaulters are individuals with relatively small debt balances of $10,000 or below.
Much of the motivation behind recent student loan forgiveness proposals comes from a desire to lessen the economic crisis from COVID-19. However, most people who are currently unemployed do not have college degrees, and thus have little or no student debt.
The national student loan debt, then, is a complex and serious issue, and college degrees are only becoming more and more expensive. But regardless of whether the government enacts debt cancellation policies, American citizens must educate themselves on the potential effects of student loan debt and act in a financially responsible manner. Students should know what their payments will look like, try to enroll in an IDR, and be prepared to make some sacrifices.