How Student Debt Stunts Financial Growth
Income-based repayment misses the mark when it comes to solving the most damaging effects of educational loans.
There was a time when conventional wisdom said that student debt is not a problem in and of itself—rather, “high” debt of $100,000 or more is the more pressing concern. A recent report from the Federal Reserve Bank of New York highlights just how out of touch that view is. A staggering percentage of Americans do not pay their student debt, no matter how big or small.
Analysis reveals that 34 percent of students with just $5,000 of outstanding debt—hardly “high”—default on their student loans. Student debt imperils far more than just individual borrowers’ monthly budgets. It erodes higher education’s ability to deliver on the promise that those who have similar abilities and work equally hard will achieve similar outcomes. Unfortunately, the prevailing policy response—Income-Based Repayment (IBR) plans—does not address the core of the problem.
Concern about rising default rates has spurred increasing calls for greater access to IBR plans, which set repayment expectations at 15 percent of the federal student-loan borrower’s post-college income. Those who do not pay off their loans within 25 years can have their remaining debt forgiven. These features make IBR schemes less a solution to actual problems and more of a sort of self-soothing device for the American people to feel better about loans. Parents and older Americans don’t want to see young adults default. Student borrowers want some reassurance that they will be able to pay off their student loans and still feed themselves. Policymakers need to say they’re doing something on the issue of student debt. In the meantime, the true threat—student indebtedness itself—continues unabated.
The Obama administration has waged a successful campaign to promote access to IBR plans—estimating in 2010 that $6.6 billion in loans would be repaid through IBR, a number that today has risen to $27 billion. This number is likely to grow even more, thanks to recent changes that have expanded “Pay-As-You-Earn” eligibility, another type of IBR scheme which caps the borrower’s monthly payment at about 10 percent of their discretionary income while forgiving their remaining debt after 20 years of making payments.
This is why IBR misses the mark: because it currently doesn’t do enough to address one of the key ways student debt may negatively affect young adults, by limiting their ability to accumulate assets. Students with outstanding student debt, even very small amounts, are more likely to postpone accumulating assets as young adults, as recent research shows. IBR plans may even exacerbate this problem by extending the period of students’ indebtedness.
Asset accumulation is important, because it positions young adults for significantly improved economic outcomes over their lifetimes—something higher education is supposed to do. The consequences of diverting income to debt repayment instead of asset accumulation may worsen the wealth divide between those who must take on debt to go to college and those who can avoid it.
Rather than a self-soothing mechanism that keeps the current financial aid model alive, it's important to start working towards a truly new direction, one that helps students get to and through college, and prepares them with a solid financial foundation upon joining the workforce. A better future is one that favors asset empowerment over debt dependency.
What might an asset-empowered future look like? Giving every child a Child’s Savings Account would be a good start. These accounts would hold an initial deposit at birth and offer the opportunity for matching funds paid through public funds. Child Savings Accounts would be a critical part of a strategy to foster expectations among very young students that they should receive postsecondary education and equip them early and often with strategies to pay for it. Researchers refer to this as helping kids develop a college-saver identity. All families would be able to save into the accounts, but public investments, like Pell Grants, could be delivered strategically to a kid’s account early enough in her academic trajectory to shape achievement and grow into larger balances.
These are admittedly long-term solutions that don’t address our increasingly urgent short-term need to help those already saddled with student debt. But, we should not invest in IBR plans with the expectation that they are a “cure”; at best, they are a costly stopgap measure that mask the underlying problem we face, over reliance on student debt. Let it be clear, IBR plans are necessary only because of a growing recognition that student debt places a destructive burden on some young adults that is counter to our view of education as the “great equalizer.” The country's financial-aid system should strengthen the return on a post-secondary degree not weaken it.
It is long past time for public policy to take a dramatic new course. It's imperative that policy makers stop thinking about financial aid as only important for influencing access to college, with the only goal being to make sure kids have money to pay for college. It's time to consider how it impacts preparation for college, access, completion, as well as young adults’ long-term financial health. Considered against this more comprehensive metric, it is clear that over use of student loans is a disturbing—even destructive—practice, and maybe just as obvious that IBR should, at best, be seen only as a short-term solution while we address the real underlying problem, over-reliance on student debt.
This post appears courtesy of New America's Weekly Wonk magazine.