Good Debt: Why Student Loans Are Better For You Than You Think

America's "Back to School Week" is here, and for many families, it means another huge batch of borrowing to cover the rising cost of college. It's important to remember how that investment can really pay off.

In April total student loan debt passed the $1 trillion mark, a mind-boggling milestone that drew heavy news coverage. All the major TV news magazines have covered the story, and this summer, the New York Times had a front-page story about Kelsey Griffith, a young woman who just graduated with a four-year degree from Ohio Northern University (an expensive private school) with, $120,000 in debt, and few prospects for a high-paying job. These sorts of stories, along with the increasing levels of student debt, have led some to call for more government support for higher education aimed at reducing tuition or even making higher education free.

While there are arguments on both sides with respect to increasing state support for higher education, student debt is an important and reasonable part of the funding system for institutions that prepare two-thirds of young people to become productive members of our economy and active members of our society. But the poor state of the economy leaves recent graduates with many fewer employment opportunities than they expected when they took on their debt. If history is any guide, these new graduates are likely to find appropriate employment in the next few years. This means that some temporary programs may be necessary to help students deal with these difficult times.

WHOSE DEBT, EXACTLY?

First, let's put that $1 trillion dollars of student debt in perspective. Americans carry over $10 trillion in housing debt to finance the ownership of assets worth significantly less than the total value of education capital produced by our universities and colleges.

Next, let's acknowledge the premise that there is no such thing as a free lunch. We currently spend $1.1 trillion a year on all levels of education, and the government covers 80 percent of the costs. Few doubt that the $650 billion that we spend on primary and secondary education (grades one through 12) is a necessary expense for our society. (The public debate over this K-12 spending is over whether the money is being spent wisely, not whether it should be spent at all.) As for post-secondary education, tuition and fees cover less than 20% of public college costs and less than 30% of private college costs.

Two-thirds of our work force does not stop at high school, with slightly more than half attaining a certificate, or an AA, BA, or graduate degree. A large number earn a combination of these awards from public two-and four-year schools, four-year private not-for-profit colleges, and two-and four-year private for-profit colleges. Each step past high school increases the earnings potential of these graduates, and each of these educational paths costs money.

The least expensive options are provided by public two-year colleges that award mainly occupational certificates and two-year degrees. The direct costs to students typically run only a few thousand dollars each year. So few students have debts and fewer default on their debt.

Graduate debt is at the opposite end of spectrum, as medical students and law students typically have debts that run up to $100,000 or more. But most of these students are quite able to handle this level of debt, as I'll explain below.

STARTING FROM ZERO

Much of the discussion of debt revolves around debt in pursuit of a BA degree. But few people realize that 35% of BA graduates have zero debt when they graduate. All of the debt figures that are publicly bandied about only refer to the 65% who have taken on debt. Among those in debt, the average at graduation was $28,000 in 2010.

In terms of high debt levels, less than one-half of one percent - about four in a thousand -- have run up more than $100,000 of undergraduate debt. And just over one-tenth of one percent, or one in a thousand, have debts of $120,000, like Ms. Griffith, the former student the New York Times wrote about. Some people will misuse debt, and some people will find themselves in unexpected trouble after taking on debt. We accept this with housing and consumer debt. If we want to allow wide access to higher education without a significant increase in cost, we need to accept it here as well.

It seems only fair that students be expected to pay for a substantial share of their education, since students derive large long-term benefits. Relative to those with only a high school diploma, students with a two-year college degree earn $400,000 more over a forty year career. Getting a BA adds another $600,000, an MA degree another $400,000 on top of the BA, and a doctorate another $600,000 to the BA. Those with a medical or law degree are at the top of the heap, earning $1.4 million more over a career than those with just a bachelor's degree.

While most students can pay their debts and derive long-term benefits from them, there is another fairness issue to consider, when deciding how higher education should be financed. In general, the children from lower socioeconomic families are much less likely to get BAs and graduate degrees than those from upper middle class and wealthy families. At the top of the educational pyramid, only ten percent of the students in top ten percent of colleges come from families in the bottom half of the income ladder.

It is these top schools that have the high "sticker prices." But only about a third of all students--those from families with high incomes--pay this rate. And the revenues from these students have been used to increase institutional grants to students from families with more modest means. So, the more government supports higher education, the more taxpayers would be subsidizing the acquisition of an important career enhancement for children from well-off families.

THE IMPORTANT ROLE OF STUDENT LOANS

While the current system certainly needs some reforms (in particular, the government has been setting up new guidelines in dealing with the high default rates on student loans from private for-profit institutions), student loans have an important role to play in financing education now an in the future.

Yes, over the last generation, the share of BA graduates with debt has increased by 20 percentage points, and the level of debt for those who take out loans has doubled. But this change alone does not make the entire system untenable. Despite the longest recession since the Great Depression, the default ratios have only crept up by a couple of percentage points, and the massive federal guarantee of student loans has yet to cost the government a penny. (The one percent charge on each loan and origination fees have more than covered the costs of the relatively few loans that have not been repaid in full).

That said, with ongoing unemployment of 8% and forecasts of weak labor markets continuing for many years, student debt is a major burden on many new graduates who can't find work or can't find good paying work in the fields they trained for. Currently, there are various forbearance options that allow students to pay just the interest on their loans plus there are consolidation options when interest rates are low. Just as we recognize that finding a job is hard for workers laid off in deep recessions by extending the time they are eligible for unemployment compensation, it seems appropriate that new labor force entrants who are having trouble finding suitable employment be given a break on making their loan payments until their employment prospects improve.

Going forward, moderate student debt will continue to be part of higher education funding. In the labor market, the pay of those with four-year and graduate degrees is at an historically high level relative to those without these degrees. Economists view this "high price" of college-educated workers to reflect the high demand that employers have for these acquired skills. It is reasonable to project that the demand for these high level skills will increase over time and that we're going to need more college-educated workers. Given the state of public budgets, some of the added expenses should be borne by the people who receive this education and financially benefit, from it. As long as low-income students have access to grants and scholarships, this seems like a fair compromise.

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