Borrowing Money to Attend College: Could the Rising Level of Student Indebtedness Lead to a National Economic Crisis
by Richard Fossey & Robert C. Cloud - July 16, 2008
The time has come to face the growing problem of college-loan indebtedness. Otherwise—like the current economic crisis that was partly caused by declining home values—college-loan indebtedness will some day contribute to enormous financial problems for a large number of individual Americans and for the nation as a whole.
Over the last eighteen months or so, the United States has experienced a major economic down turn, marked by falling house prices, a jittery stock market, and the so-called credit crisisa seizing up of credit markets as national and international lenders become reluctant to loan money based on concern about the immediate financial future.
Many college and university students may feel that they have little stake in this economic downturnafter all, few traditional-age college students own houses, hold stocks, or have significant financial assets. Recently, however, the larger national economic situation has begun to affect some college students in a very direct way as many are finding it increasingly difficult to obtain loans to pay their educational expenses. According to a recent New York Times article (Glater, 2008), several major banks are scaling down their college loan business, with some declining to grant college loans to community college students. For example, California financial aid officials have reported that Citibank has stopped making college loans to all community college students in the state (Glater, 2008).
The reasons that banks have become more reluctant to make college loans is not entirely clear, but some banks are apparently finding the student loan business unprofitable in the current economic climate, particularly the small loans those community college students typically obtain. A reduction in federal subsidies for lenders may also be contributing to the banks behavior. If the problem continues or gets worse, a lot of potential college students may find that it is impossible for them to borrow the money they need to pursue postsecondary education.
Even without this recent development, however, there are signs that college student loans may be a looming economic crisis of major proportions. Twenty-five years ago, students took out less than $8 billion in student loans (DeWitt, 1995). By last year, that figure had grown almost ten fold. In 2006-2007, students borrowed $78 billion for undergraduate or graduate education (College Board, 2007). If this loan volume continues (and it is likely to go up), postsecondary students will borrow almost a third of a trillion dollarsthats right, trillionover the next four years. That is a gigantic amount of debt to be carried by a small segment of the national populationjust those Americans who attend postsecondary institutions.
Of course, some postsecondary students borrow more than others; and some borrow nothing at all. Nevertheless, the average accumulated debt load for college graduates is rising. According to the Project on Student Debt, the average debt load for college graduates who borrowed money to pay their college expenses was about $21,000 for the class of 2006 (Project on Student Debt, 2007).
Student-Loan Default Rates are Low: Does That Mean We Have Nothing to Worry About?
Of course, as the nations colleges and universities never tire of telling usthe money students borrow to attend college is usually a very good investment not only for the student but for society as a whole. As the College Board noted in its 2007 report, Education Pays, the income gap between high school graduates and college graduates has increased significantly in recent years. And higher levels of education correspond to lower unemployment and poverty rates (Baum & Ma, 2007, p. 2).
In addition, the default rate on student loans, as measured by the U.S. Department of Education (DOE), has dropped in recent years, another indication that borrowing money for a college education is a worthwhile thing to do and that most student borrowers are financially able to pay the money back. In September 2007, DOE reported that the student-loan default rate for FY 2005 was only 4.6 percent (U.S. Department of Education, 2007).
But lets take a close look at the student-loan default rate that DOE reports. Does DOEs rate provide an accurate indicator of the default rate on college loans?
First, we should bear in mind that DOEs default rate measures the percentage of students who default on their student loans during the first two years after they become due. DOEs rate tells us nothing about the number of students who default later in the repayment period. A 2006 report by the National Center for Education Statistics (NCES) (which is a unit of DOE) looked at student loan default rates over a ten-year period. NCES found that on average, defaults occur four years after graduation, so a lot of loan defaults are not picked up by DOEs method of measurement (Choy & Li, 2006). According to the NCES report, the overall college-loan default rate for 1993 college graduates over the ten year period after graduation is 9.7 percentconsiderably higher than the default rate reported by DOE for FY 2005, although the two rates are not directly comparable (Choy & Li, 2006; Dillon, 2007).
Secondly, NCES statistics found that students with high amounts of college-loan debt were much more likely to default on their loans than students with more manageable debt levels. Specifically, students who graduated in 1992-1993 with $15,000 or more in college loans were about three times more likely to default than graduates who had $5,000 or less in student-loan debt (Dillon, 2007). Likewise, graduates with relatively high incomes defaulted less than graduates with low incomes.
NCESs 2006 report is an indicator that DOEs officially reported student-loan default rate may not be the best indicator of the rate at which debtors are defaulting on their student loans. As the NCES report found, a significant percentage of borrowers do not default immediately after their loans become due; they typically default laterabout four years into the repayment period. If the economy deteriorates, we will probably see more student-loan borrowers default, even debtors who made regular payments on their debt over a period of many years.
Borrowing Money to Attend College: It Doesnt Work Out Well for Everyone
In short, borrowing money to attend college does not work out well for everybody. What kinds of students are more likely to run into trouble when trying to pay back their college loans?
First, it has been known for many years that students attending for-profit trade schools have higher student-loan default rates than four-year college students and that trade school students sometimes do not get good educational value for their tuition dollars (General Accounting Office, 1998).
Second, students who fail to complete their studies also have higher default rates, and again these students do not receive full value for their educational dollars. In a 2005 study, Lawrence Gladieux and Laura Perna found serious negative consequences of the college loan trend for students who borrowed money to attend college but who did not receive a degree. For students who began at four-year institutions and expected to attain a bachelors degree, Gladieux and Perna reported, borrowers who dropped out were twice as likely to be unemployed as borrowers who received a degree, and more than ten times as likely to default on their loan (p. 2).
Gladieux and Perna stated that their findings provide an alert to policymakers and educational leaders, who can hardly be satisfied when so many students leave school with no credential, a debt to repay, and a high risk of defaulting on that debtor with no debt, no degree, and therefore little gain in earning power to offset the time and money invested in postsecondary education. They urged policy makers and educational leaders to establish policies and programs to better prepare, support, and guide students, especially low-income students, in completing their degrees. In addition, Gladieux and Perna urged educational leaders to do all they could to assist students in making appropriate decisions about the use of loans to finance the costs of their postsecondary education (p. 2).
When we look at reported court cases involving student-loan debtors who file for bankruptcy, we find other evidence that some college-loan borrowers fail to benefit financially from their educational investments. Bankruptcy court decisions describe bankrupt student-loan borrowers who were unable to pay back their student loans due to unemployment, divorce, or illness (Fossey, 1997), including a significant number of bankrupt student-loan debtors who claim to have been economically handicapped by mental illness.
Even in the best case scenariothe four-year college student who borrows a reasonable amount of money to obtain a bachelors degreethe benefits of taking out a student loan may not be as great as some people think. In a recent controversial letter to College Board president Gaston Caperton, Charles Miller, former chairman of the University of Texas System Board of Regents, challenged the College Boards overall rosy conclusions in its Education Pays report about the economic benefits of higher education. Indeed, Miller charged, based on reasonable financial calculations, it is reasonable to conclude that a college degree is not as valuable as has been claimed (Miller, 2008; Lederman, 2008, p. 4).
Miller pointed out that the cost of college has risen so rapidly in recent years that it might one day overwhelm the average earnings growth of the typical graduate, especially when considering that global competition and the outsourcing of technical and white collar jobs is putting downward pressure on many college graduates earnings (Miller, 2008, p. 2).
Miller concluded his challenging letter to the College Board president by asking a series of provocative questions:
Could the high college dropout rate in America actually be providing evidence that the costs of college are too high for the economic benefits produced for the individual?
Could college dropout rates and low college participation rates actually be the result of rational economic decisions by prospective students?
Could the cost of college be keeping low-income families from even the opportunity to benefit from attending college?
Most chillingly, Miller asked this question: Could the cost of higher education in the current form have reached a level too high for a positive economic return to society as a whole, as well as the individual? (p. 4).
Obviously, Millers concerns have tremendous implications for students who borrow money to attend college. If the economic value of a college degree is diminishing, then it may be increasingly unwise and financially risky for students to go into debt in order to pay for a college education.
Even Graduates of Prestigious Professional Schools Do Not Always Benefit from Student Loans
Some people may think that graduates of prestigious professional schoolsprograms in business, law, or medicine, in particularalways come out winners when they borrow money to further their education; and in general, this is probably true. But even this assumption is not always valid.
Take the case of Michael Young, a graduate of Southern Methodist University School of Law, who filed for bankruptcy after accumulating $235,000 in student-loan debt (Educational Credit Management Corporation v. Young, 2007). Young graduated from SMUs law school in 1993, borrowing money to finance his education. Apparently, the law degree did not provide Young the job opportunities he had hoped for, so he applied to and was accepted to a graduate law program at Georgetown University. Again, he took out student loans to pay for his further legal education.
Unfortunately, even with two law degrees from prestigious universities, Young was unable to find a lucrative job in the legal field. His financial circumstances were also impacted by a divorce (p. 798). Eventually, Young filed for bankruptcy, seeking to discharge nearly a quarter of a million dollars in student-loan debt. At the time of the bankruptcy courts decision in 2007, his annual salary was only $46,000.
As several legal scholars have written, discharging college-loan debt in bankruptcy is extremely difficult; one might say it is nearly impossible absent severely dire circumstances (LeMay & Cloud, 2007). In Youngs case, the bankruptcy court concluded that Young had failed to establish an undue hardship that would justify the discharge of his student loans in spite of the fact that his debt was an enormous burden based on his current income. The court ruled against Young even though the court admitted that Young faced difficult prospects in finding a well-paying job in the highly competitive legal job market (Educational Credit Management Corporation v. Young, 2007, p. 800).
Thus, fourteen years after graduating from SMU Law School, Young was faced with servicing a very large student-loan debt on a very modest income. If unpaid, this debt will literally follow Young into his old age. In 2005, the Supreme Court ruled that an individuals Social Security check could be garnished to help satisfy unpaid college loans (Lockhart v. United States, 2005; Cloud, 2006).
Borrowing Money to Pay for Postsecondary Education: What Does the Future Hold?
If the past is any indication of the future, American students will borrow more and more money in the coming years to pay for undergraduate and graduate education. Andif the present trend persistscollege tuition costs will continue to outstrip the nations annual inflation rate, fueling the trend for college students to borrow more and more money to finance their education.
Clearly, this trendlike ever-rising property values for residential real estatecannot go on forever. At some moment in time, there is a point beyond which it will not make sense for many students to borrow money to finance their postsecondary education. People may quibble with Charles Miller about the details of this calculation, but Miller is surely right to warn that as a nation we are much closer to this moment than many people realize.
What then should we do? Some solutions are glaringly obvious. First, as college loan counselors caution repeatedly, students should not borrow more money than they need for their educational expenses and should not use student loans to finance a lifestyle that their present economic status does not support. And students should be very judicious about choosing the academic program for which they wish to borrow money. To cite the Young case, for example, if obtaining one prestigious professional degree does not lead to a well-paying job, it may not make sense to borrow more money to obtain a second professional degree in the same field. Students need to be very aware that taking out a student loan is a lifetime obligation until it is repaid; absent very unusual circumstances, college loans cannot be wiped out in bankruptcy.
Second, colleges and universities must do all they can to keep their operating costs down in order to slow the galloping rate at which college tuition rates are rising. College officialsfrom the university president to the lowly assistant professorneed to be aware that operating inefficiencies in higher education are paid for by students with borrowed money and undermine the fair value of the higher education experience.
Finally, in our considered opinion, the bankruptcy laws need to be relaxed to make it easier for bankruptcy courts to provide debt relief to college-loan borrowers who make good-faith mistakes and borrow more money than they can reasonably pay back.
Our nations current harsh stance toward college-loan defaulters is based on the very reasonable fear that allowing people to wipe out their college-loan indebtedness in bankruptcy would encourage fraud and raise the overall cost of the federal college loan program. But surely some humane mechanism can be designed that will give relief to student-loan debtors who borrowed money to attend college but did not benefit financially from the experience. Do we really want the federal government to garnish the Social Security checks of elderly people who failed to pay back their student loans?
What is at stake if the nation does not rein in student-loan indebtedness? Like the nations overall level of indebtedness due to governmental deficit spending and irresponsible consumer borrowinghigh levels of student loan indebtedness will eventually weaken the nation. The next generation of working Americans will not be in a position to buy homes, raise families, save for retirement or invest in the economy if they are overly burdened with the debt they accumulated to get their postsecondary education.
We realize that the issue of how higher education should be financed is complicated and that many colleges very existence currently depends on maintaining a steady flow of student loan dollars into institutional coffers. Changing the current policy that forces millions of students to borrow heavily in order to attend college will not be easy.
Nevertheless, the time has come to face the growing problem of college-loan indebtedness. Otherwiselike the current economic crisis that was partly caused by declining home valuescollege-loan indebtedness will some day contribute to enormous financial problems for a large number of individual Americans and for the nation as a whole.
Baum, S., & Ma. J. (2007). Education pays: The benefits of higher education for individuals and society. New York: NY: College Board.
Choy, S.P., & Li, X. (2006, June). Dealing with debt: 1992-93 bachelors degree recipients 10 years later. Washington, DC: National Center for Education Statistics.
Cloud, R.C. (2006). Offsetting Social Security benefits to repay student loans: Pay us now or pay us later, Education Law Reporter, 208, 11-21.
College Board (2007). Trends in student aid. New York, NY: Author.
DeWitt, K. (1995, September 22). Student loans show sharp rise, report says. New York Times.
Dillon, E. (2007, October 23). Educationsector.com. Hidden details: A closer look at student loan default rates. Retrieved June 17, 2008 from www.educationsector.org/analysis_show.htm?doc_id=559757
Educational Credit Management Corporation v. Young, 376 B.R. 795 (E.D. Texas, 2007).
Fossey, R. (1997). The certainty of hopeless: Are courts too harsh toward bankrupt student loan debtors? Journal of Law & Education, 26, 29-48.
General Accounting Office (1988, June). Defaulted student loan: Preliminary analysis of student loan borrowers and defaulters. GAO HRD 88-1128. Washington, DC: Author.
Gladieux, L., & Perna, L. (2005, May). Borrowers who drop out: A neglected aspect of the college student loan trend. National Center for Public Policy and Higher Education. San Jose, CA: Author.
Glater, J. D. (2008, June 2). Student Loans Start to Bypass 2 Year Colleges, New York Times, p. A1.
Lederman, D. (2008, April 7). College isnt worth a million dollars, Inside Higher Education, retrieved June 17, 2008 from http://insidehighered.com/news/2008/04/07/miller
LeMay, C.A., & Cloud, R.C. (2007). Student debt and the future of higher education. Journal of College & University Law, 34, 79-110.
Lockhart v. United States, 546 U.S. 142 (2005).
Miller, C. (2008, April 2). Letter to Gaston Caperton, President, the College Board. Retrieved June 17, 2008 from http://insidehighered.com/news/2008/04/07/miller
Project on Student Debt (2007, September). Student debt and the class of 2006. Berkeley, CA: Author. Retrieved June 17, 2008 from http://projectonstudentdebt.org/files/pub/State_by_State_report_FINAL.pdf
United States Department of Education (2007, September 10). Press release: Student loan default rates remain low. Retrieved June 17, 2008 from http://www.ed.gov/print/news/pressreleases/2007/09/09102007.html