Education

Why Fixing Student Loan Interest Rates Doesn’t Fix The Problem

On July 6, President Obama signed a bill that will hold student loan interest rates at 3.4% for the next year.  Students all over the country greeted the bill with relief.  With college tuition rates increasing faster than the inflation rate, students are relying more and more on loans to pay for their education.  Tuition for private institutions has nearly tripled from $10,144 in 1981 to $28,600 in 2011 and for public universities the cost has almost quadrupled from $2,242 in 1981 to $8,244 in 2011.  These spikes in tuition are rising at a rate that fast outpaces overall inflation rates.

Tuition Hikes Far Outpace Overall Inflation

What is causing this over-inflation of college tuition?  It all comes back to basic supply and demand.  The first part comes from a rise in students looking for a post-secondary education.  College degrees are becoming more and more necessary, even for jobs that didn’t previously require a college degree.  Furthermore, it has been shown that these climbs in enrollment are exasperated during times of recession.  It seems that during financially difficult times, students are looking at college as a means to a financially stable future.  This is causing an over-saturation and inflation of college degrees.

Colege Enrollment Growth

The second part is in order to meet this new demand, there is an over-financing of loans to unqualified students.  In an article published in Moneyland, Kayla Webley sums it up perfectly when she says, “What’s really needed is a long look at how higher education in the U.S. is financed.  Many would argue the current model is fundamentally broken.  Virtually everyone who applies is approved for almost unlimited student loans, regardless of how likely they are to be able to pay them back.  But lenders aren’t really concerned about that because student loans cannot be discharged in bankruptcy.  They know they’ll get their money back one way or another.”  Essentially, lenders have no incentive to deny unqualified candidates a loan and colleges have no incentive to decrease tuition, because they know students will come up with the money.  This problem has been furthered since the federal government has taken over the majority of all subsidized college loans.  Now post-secondary institutions know that these loans are going to be given out, with treasury backed money.  Therefore, they are even less likely to reduce tuition costs in order to be competitive.  The federal government currently holds 88% of the market for student loans.

Federal Loans Dominate

While student loan debt has not yet reached the point of crisis, the accumulation of debt is steadily on the rise.  It is currently the fastest growing form of debt, passing mortgages and credit card bills.
Student Loans Fastes-Growing Category of Household Debt

Secondly, defaulting on loans is highly correlated with unemployment.  While intuitive, this point is important because unemployment for recent graduates is at a staggering 19%.  That’s a scary number, for someone who looked at investing in college as a means for security.  That’s why movements for student debt forgiveness have had such success on websites such as Signon.org and now backed by Rep. Hansen Clarke of Michigan.  Their argument as that recent graduates are so consumed with debt that they aren’t entering the market, they’re not buying cars, they’re living at home, etc. and that forgiving their loans will be a stimulus for the economy.  What do top economists have to say about that?  Worst. Idea. Ever.  A bailout would be a one-time fix, that wouldn’t help people who want an education in the future.  Furthermore, forgiving the $1 trillion dollars of debt, would not equal a $1 trillion dollar stimulus into the economy.  There is no evidence that being debt free would highly alter student’s spending habits.

So what’s the fix?  Well from and individual standpoint, Sallie Mae, has great information about how to take out the right loan for you.  This is ironic, as Sallie Mae is a private lender, which many have accused as being the source of the problem, not the solution.  However, their approach is smart and systematic.  They approach student loans, like any other investment, not advising taking out loans that are beyond the student’s means.  So how much money do you really need for college?  A good rule of thumb is to take the industry you want to go into, calculate your expected first year salary and don’t borrow over that amount.  Therefore, if you expect to make $35,000 a year, don’t borrow over that amount.  Simple right?  Well, if the government would allow companies whose job is to make shrewd and simple investments, as illustrated above, to give out these loans, then not only would the feds not have to scramble to cover the $65 billion dollars it will most likely cost them to keep the interest rates at 3.4%, but students would no longer qualify for loans they can’t pay back.  They might even be able to get more competitive rates.

Secondly, the federal government needs to reorganize its qualifications for Pell Grants.  Pell Grants are essentially scholarships designed to help those who come from low-income families attend college.  While these grants are necessary, they are fundamentally flawed in that they have zero stipulations other than maintaining a 2.0 GPA.  Therefore, because, based on their income level, many of these students come from under-performing schools, they are not fully ready or qualified to attend college.  This leads to many of these students not making it through to graduation and wasted federal money.  Furthermore, there are no stipulations as to what type of schools they can go.  This leads to many Pell grant recipients attending schools and obtaining degrees that don’t prepare them for a career.  Therefore, these Pell grants aren’t always creating citizens that are contributing to the economy.  There needs to be graduation, performance, and career incentives in order to make the Pell grant system more effective.  If not, then the $9.3 million spent on Pell Grants, could go to help more eligible students who have to take out loans instead.

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One thought on “Why Fixing Student Loan Interest Rates Doesn’t Fix The Problem

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