STUDENT DEBT COSTS AND EFFECTS
Norgelys Martinez
New Jersey City University
Abstract
The increase in the amount of student debt is growing each year. As well as, the cost of borrowing and how it affects millions of students’ lives. I will focus on how these lump sum amount of loans and student debt affects your everyday life even after graduation. The proposed methodology is to give insight on how these loans affect everyday life. You will also see how knowing finance is important when it comes to knowing which loans will be better for you and how being able to calculate your loans before you take them out is important. Finance is not only related to how much a person might get from their stock on the stock market but also a means for students on a personal basis to understand what options they have and what can help them in terms of taking out that loan or paying off their debt. The various types of loans are also described in this paper and how knowing which loan is better for you can help lessen the burden of student loans.
Student debt is a problem people of all ages encounter. From undergraduates to graduates and even after graduation, 20-30 years later some people are still paying off their student debt. More than 45 million borrowers are lugging around a combined $1.45 trillion in student loan debt that they have not paid back yet, according to LendEDU.com, a marketplace for private student loans and student-loan refinancing and consolidation. Nearly 7 million federal-loan borrowers alone are in default on a total of $113.5 billion in student loans. And student loan debt is the second-largest pile of debt in the U.S., trailing only mortgages (KATZEFF 2018).
Education is a very valuable asset to have including your degree and all the knowledge absorbed from all those days in class. The problem with taking out student loans is that some people do not know what they are getting into and they do not understand how much the loan will costs after accruing interests. Having a student loan and not being able to pay it off in a timely manner affects your everyday life. When you are looking to buy a home or a car having that student debt adding up does not help you get that home you dreamed of because they will see you still have not been able to pay off your student debt so they come to the conclusion that it will be the same thing with the house or car you are trying to buy.
Part of the problem with student loans is that it is not broken down and explained to students. Financial literacy has been shown to impact students’ understanding of the long-term consequences of debt and may lead to reduced borrowing behavior. However, the general finding is that financial literacy among students is low (Perkins, D., Johnston, T., & Lytle, R. 2016). Being that the financial literacy is low proves the point that students do not realize or understand what they are getting themselves into. As students, some with financial aid, the loans are offered, and you may accept or decline the offer. No one really takes the time to explain how the loan works and the repayment plan needed to pay it off.
Students that are taking out loans should calculate how much the loan will cost them and see if they will be able to pay off that amount in the time granted for the loan. Being able to see the actual costs after interest is accrued helps give students a better idea of how much altogether they will have to pay back. To calculate your student loan interest is simple when you know the terms of the loan. For example, let’s say you borrow $10,000 at a 7% annual interest rate on a ten-year standard repayment plan. Your monthly payment would be $116. You must divide the 0.07 annual interest rate by 12 months in a year to get 0.006(i). Then you must multiply the 10 years of the loan by 12 months in a year to get 120 (n) payments needed to pay off loan. We use the following formula:
Discount Factor (D) = {[(1 + i) ^n] – 1} / [i (1 + i) ^n]
When we plug in our number we get:
{[(1 + .006 ) ^120] – 1} / [.006(1 + .006)^120] =86.20
P=A/D 10,000/86.20 = $116
If you calculate your daily interest rate you would get .07/365 = 0.00019 the same as 0.019% that is diving your annual student loan interest rate (7%) by the number of days in a year (365). To calculate the amount of interest your loans accrues per day you must multiply your outstanding loan balance (10,000) by your daily interest rate (0.00019) so $10,000 x 0.00019= $1.90 added each day of your loan. To find your monthly interest payment you multiply your daily interest amount (1.90) by the number of days since your last payment (30 days since paying monthly), we get $1.90 x 30 = $57.
To conclude this example that means that each month you will pay $116 and each month you accrue $57 in interests on your loan. Being able to calculate that will help you to know if you can afford to take out the loan. If you can afford $116 monthly payments into your budget and still live comfortably then go for it, if not then you know that loan is not for you and you decline it. Finance and knowing these calculations make it a lot easier to understand whether you may or may not be able to afford taking out that loan.
The terms of the loan are very important to follow in terms of monthly payments as well as the time it takes you to pay off the loan, in the previous example it means paying it off in ten years. If you do not pay off the loan in the amount of time the loan was given to you then you may end up defaulting. Defaulting is when you have not made any payments within 270 days, approximately 9 months. Once you default and the federal government is involved is getting the money back they can arrange to take money out of your check directly or keep social security money as well as tax refunds in order to get back all the money borrowed back since you did not make any payments. During that time that you did not make a payment any credit card applications will be declined and anything that requires a credit check will show that you are defaulting and will not allow you to purchase that car you’ve been wanting or get a new credit card you were excited to get. Creditors will be aware of your credit standing and will not want to do business with you because they can already see how it will be to get the money back.
The government has also been known to sue borrowers. The Department of Justice reports that in the past two years, over 3,300 student loan borrowers have been sued for defaulting. In almost every case, the borrower loses. If the government wins, they can place a lien on your home and even force a sale (Hess 2017). Student loans take a toll on your life if you cannot handle it so when you are looking at different loans take into consideration the monthly payments and how long you have to pay that loan off in order to consider which loan is the best option for you.
Student loans have an attractive feature that most debt doesn’t have: payments can adjust to current income levels. Direct federal student loans enable borrowers to apply to make their payments a fixed percent of their discretionary income, with the percent ranging from 10 percent to 20 percent depending on the program. These programs also set a maximum number of years that people have to pay, up to 25 years, and any debt remaining at the end of that period is forgiven. There are other advantages that student loans have over most other forms of debt. During periods of unemployment, a borrower can apply to suspend payments on federal student loans until the borrower resumes work (note this doesn’t apply to private student loans). And interest paid on these loans is tax deductible up to $2,500 annually. One downside, though, is that student loan debt is extremely difficult to eliminate through bankruptcy (Elvery 2016). Although there seems to be an attractive feature of student loans it is those same features that students take on these loans thinking they will be able to pay them off when in reality they are in way over their heads.
As mentioned before, having lump sums of student debt affects individuals lives without them understanding at what cost. From the same article of (Elvery 2016) he mentions something that correlates with my point. The article states “Recent research has looked at the link between student loans and homeownership and wealth accumulation. Researchers from the Federal Reserve Bank of Boston find that compared to other people who attended college, student loan borrowers are less likely to own a home and that a 10 percent increase in student loans is associated with about 1 percent lower total net worth.
But, if people can only afford college by borrowing, we would want to compare student loan borrowers to people who never went to college. Stephan Whitaker of the Federal Reserve Bank of Cleveland finds that millennials with student loans were more likely than millennials without student loans between 2007 and 2015 to move to a higher-income neighborhood, a sign of economic mobility. The people without student loans included both people who never attended college and people who attended college. If it were possible to compare student loan borrowers only to people who did not attend college, the differences in mobility would almost certainly be even larger.”
The most recent reports indicated by Student Loan Debt Statistics 2018 shows there is:
• National Student Loan Debt – $1,520,000,000,000 ($1.52 trillion)
• Overall Number of Student Loan Borrowers – 45,000,000 (~70%of college students)
• Student Loan Default Rate – 11.5%
• Student Loan Delinquency Rate – 5.41%
• Average Debt Per Student Borrower – $27,975
(Resource: Federal Reserve Bank of New York Consumer Credit Panel/Equifax, Federal Student Loan Portfolio)
Compared to Student Loan Debt In 2017
• Total Student Loan Debt: $1.31 trillion
• Total U.S. Borrowers with Student Loan Debt: 44.2 million
• Student Loan Delinquency or Default Rate: 11.2%
• Total Increase in Student Loan Debt In 4Q2016: $31 billion
(As of 4Q 2016, New York Federal Reserve)
In a year, total student loan debt went from 1.31 trillion in 2017 to 1.52 trillion in 2018 which is a 2.1 billion increase in a matter of 365 days. Total U.S. Borrowers with Student Loan Debt increased 800,000 in the same amount of time. These numbers give us the knowledge we need to know to understand how much student debt is increasing by the year and the toll it takes on students’ lives. Figure 1 below represents Federal student loans categorized by age and how much debt they have accumulated as of June 30, 2018 obtained by Federal Student Loan Portfolio 2018. As you can see, the largest amount of borrows was 3.46 million in the age group of 25-34 with the outstanding balance of $99.42 billion! People aged 25-34 are still in their prime and making good money but that does not mean they have $100 billion laying around in order to help pay off their student debt.
Looking at the graph from the older individuals’ perspective is also ludicrous. In the age range of 62 and older there are 0.11 million borrowers who owe $15.15 billion! At that age you want to be putting away for life insurance and retirement not still paying off student debt, that is ridiculous. These are the people who agreed to take the loan and did not know what they were doing. They had no idea at age 70 they would still be paying off that student loan.
A detrimental part of student loans is that there are different kinds of loans available to students and they do not take the time to research and find out which loan is better for their situation. Most students think of loans as a way to pay for school but also, they figured I should take the one that’s offering me more money because it is better, when in reality that is not the case. Some of the different loans that are available to students are subsidized and unsubsidized (also called Stafford), private loans, grad plus, parent plus, Perkins and consolidation. If you go in blindly and choose whichever loan gives you more money without thinking of the interest rate or how long they will give you to pay off your student debt then you will not choose what is best for you and you will most likely end up defaulting or not being able to pay off your debt because you thought bigger was better and when you don’t know those terms most likely it will not be a better loan because they payed you more you must do your own research and find out what each one means and which will be a better investment for you and your education.
Subsidized and unsubsidized loans are both federal loans which means they are funded by the government, but the terms are not the same. The U.S. Department of Education pays the interest on a Direct Subsidized Loan
• while you’re in school at least half-time,
• for the first six months after you leave school (referred to as a grace period*), and
• during a period of deferment (a postponement of loan payments).
Direct Unsubsidized Loans are available to undergraduate and graduate students; there is no requirement to demonstrate financial need.
• Your school determines the amount you can borrow based on your cost of attendance and other financial aid you receive.
• You are responsible for paying the interest on a Direct Unsubsidized Loan during all periods.
• If you choose not to pay the interest while you are in school and during grace periods and deferment or forbearance periods, your interest will accrue (accumulate) and be capitalized (that is, your interest will be added to the principal amount of your loan).
(Federal Student Aid)
As you can see with these two loans that sound similar the terms are very different one will pay the interest for you while in school while the other you are required to pay the interests and if you do not it will accrue and be added to your principal. Private loans as you could probably guess is private it is not funded by the government but by a lender such as a bank, credit union, state agency, or a school.
More about private loans:
• Many private student loans require payments while you are still in school, but some do allow you to defer (put off) payments while in school.
• Private student loans can have variable or fixed interest rates, which may be higher or lower than the rates on federal loans depending on your circumstances.
• Private loans differ by lender and by type of loan. Be sure you understand the terms of your loan and keep in touch with your lender about any questions you may have.
Grad PLUS loans or Direct PLUS loans are different loans that may assist you with paying for school, McGurran 2018 explains how Grad PLUS loans differ from other types of federal loans in that:
• PLUS loan interest rates are higher: 7.6% compared with 6.6% for unsubsidized graduate student loans.
• PLUS loans have an origination fee of 4.264%, which is deducted from the loan money you receive. The fee for subsidized and unsubsidized loans is 1.066%.
• PLUS loans require a credit check.
The Parent PLUS Loan on the other hand, is a federal student loan available to the parents of dependent undergraduate students. The Parent PLUS Loan offers a fixed 7.6% interest rate for the 2018-2019 school year and flexible loan limits. To be eligible, a parent can’t have an adverse credit history. Parent PLUS Loans have a 4.248% origination fee (Parent PLUS Loan Overview). These loans are available to help students, but it is recommended to students to check other direct loans before considering Parent PLUS because it involves higher interest rates.
The next kind of loan is called the Perkins Loan, which are low-interest federal student loans for undergraduate and graduate students with exceptional financial need. The Perkins loan repayment plan is as follows. If you are attending school at least half-time, you have nine months after you graduate, leave school, or drop below half-time status before you must begin repayment. If you are attending less than half-time, check with your college or career school to find out how long your grace period will be (Federal Student Aid). This loan has the benefit of not having to pay until nine months after graduation when you are enrolled part time which is beneficial for some in order to save up the money to start repayment.
Finally, something that might make life a little easier, there is consolidation loans. A Direct Consolidation Loan allows you to consolidate (combine) multiple federal education loans into one loan. The result is a single monthly payment instead of multiple payments. Loan consolidation can also give you access to additional loan repayment plans and forgiveness programs. Doing your research will help a lot with this kind of loan because you may be able to have your loan forgiven as per terms of your loan after a certain amount of time. That’s not to say you don’t pay anything and then after 25 years they forgive your loan, it does not work like that. To be considered for loan forgiveness you have to make a certain amount of payments over the year to be eligible. The Public Service Loan Forgiveness (PSLF) Program forgives the remaining balance on your Direct Loans after you have made 120 qualifying monthly payments under a qualifying repayment plan while working full-time for a qualifying employer (Federal Student Aid).
In Figure 2, you can see how many people have taken out the various loans described in this paper. Twenty-nine million borrows have subsidized Stafford loans, which again is the loan that pays the interest on the loan until after 6 months after graduation. This loan is the most common and most taken out because you do not have to worry about paying any interest until after you graduate and after graduation most people have already gone into their field of work and think they can pay it off right after graduation, although that is not always the case. The second most used loan coming in at 27.6 million borrowers is the unsubsidized loan which is when you are completely responsible for everything as per your loan’s terms. Subsidized and unsubsidized are the most common loans so it makes sense that both those loans combined makes up almost 75% of the portion of borrowers that out. They also add up to $720 billion of debt of the loan combined.
The loan with the least borrowers surprisingly is the Grad PLUS loan with 1.0 million borrowers. This loan is used the least because it requires a credit check and most students when they enter college either do not have any credit or have very little credit which does not qualify them for the loan. The second lowest borrowed loan is the Perkins loan with 3.0 million borrowers. This low interest loan for students with exceptional financial need is less borrowed because students are not eligible for it because they only offer it to students who have a very low income and know that they will not be able to pay for school
Loan Type Outstanding Debt (billions) Portion of Total Debt Borrowers (miilions) Portion of Borrowers
Subsidized Stafford $270 20.2% 29.0 38.3%
Unsubsidized Stafford $450 33.7% 27.6 36.5%
Grad PLUS $57.0 4.26% 1.10 1.45%
Parent PLUS $80.5 6.02% 3.40 4.50%
Perkins $7.80 0.58% 2.60 3.43%
Consolidation $472 35.3% 12.0 15.9%
otherwise. The Perkins loan accounts for $7.80 billion of outstanding debt which is the least amount compared to all the other loans. Looking at the Figure 2 you can see that Parent PLUS loans has more borrowers than the Grad PLUS loans which means more parents are taking out loans for their kids to go to school than actual graduates are which is not good being that the Parent PLUS loans has very high interest rates.
Federal Funding Distribution by Loan Type
Some tips for paying off that debt include checking your workplace benefits, considering setting up an automatic payment program and being realistic among others as described by Katzeff in his article
Check your workplace benefits. See if your employer offers student-loan repayment benefits. Consider setting up an automatic payment program. "Student loan servicers almost always provide a 0.25% discount for auto-pay, which can really add up over the life of a loan," Matherson said. "Plus, by using auto-pay, borrowers don't need to worry about making on-time payments each month." Late payments can hurt your credit score and cost you extra in fees, he says. Be realistic -Make sure your repayment fits your budget. "(The) fundamentals need to be there to make sure you can afford your payment before you set up the plan," Amis said. Some automatic payment programs work by transferring from your bank account to the loan-service provider's account, like any online bill-payment program.
Some of the points made by Katzeff’s source make sense, if you set up an automatic payment program even it is just to take out $40 a month you don’t have to worry about being late they will take it out and you will not even notice it is gone. The most important part of trying to repay alone is setting budget where you can live comfortably but still be able to have some money to put towards the loan. If you wait until after you graduate to start saving to repay your loan you’re going to have a rough time getting the money together. The best way to repay the loan is to start saving immediately and make payments when you are supposed to.
Student debt is increasing yearly but that does not mean borrowers cannot be more intellectual and more responsible to start saving as soon as you can instead of waiting until the last possible moment to begin repayment. Researching is also a big key factor when figuring out which loan is best for each individual’s needs. Finding out specifics in terms of interest rates and years of the loan is very important. As I showed earlier in the paper calculating how much your loan will be and how much money in interests will accrue will help you know if you will be able to afford the loan and how much the monthly payments will be. Everyone wants to go to a good school and get a degree but not everyone has the means to pay for it in that moment or in the future when it comes time to pay it back. Student loans not only affects your pocket, but it also affects your life.
Not being able to pay off your loan or having your loan go into default affects your credit. Once you have bad credit you cannot do things you wanted to do, for example, buying a car or a home, banks and dealers will see your defaulted loan and will not want to make business with you because you are not reliable and they will not see their return on investment if they make a contract with you. Student loan debt is the second-largest pile of debt in the U.S., trailing mortgages. There are many options for loans as described before, from subsidized and unsubsidized to consolidation loans but it is a matter of figuring out what is best for you. Your loan can make you or break you, learning the terms before you agree is crucial. Being able to calculate it yourself is very beneficial and a super skill you learn from finance-put it to good use and don’t let yourself get pulled into another one of the millions of students in debt.
References
Federal Reserve Bank of Boston. (2014, December 02). Student Loan Debt and Economic Outcomes. Retrieved from https://www.bostonfed.org/publications/current-policy-perspectives/2014/student-loan-debt-and-economic-outcomes.aspx
Federal Student Loan Portfolio. (2018, September 25). Retrieved from https://studentaid.ed.gov/sa/about/data-center/student/portfolio
Federal Versus Private Loans. (2018, August 24). Retrieved from https://studentaid.ed.gov/sa/types/loans/federal-vs-private
Friedman, Z. (2018, March 28). Student Loan Debt In 2017: A $1.3 Trillion Crisis. Retrieved from https://www.forbes.com/sites/zackfriedman/2017/02/21/student-loan-debt-statistics-2017/#78cba76a5dab
Hess, A. (2017, August 15). Here's what happens if you don't pay your student loans. Retrieved from https://www.cnbc.com/2017/08/15/heres-what-happens-if-you-dont-pay-your-student-loans.html
Joel Elvery Economist Joel Elvery’s primary fields of interest are labor. (2016, May 16). Is There a Student Loan Crisis? Not in Payments. Retrieved from https://www.clevelandfed.org/newsroom-and-events/publications/forefront/ff-v7n02/ff-20160516-v7n0204-is-there-a-student-loan-crisis.aspx
Loan Consolidation. (2018, October 22). Retrieved from https://studentaid.ed.gov/sa/repay-loans/consolidation
McGurran, B., B., NerdWallet, & Associated Press. (2018, October 16). Federal Direct PLUS Student Loans 2018 Review. Retrieved from https://www.nerdwallet.com/blog/loans/student-loans/expert-advice-direct-plus-loans/
Parent PLUS Loans – Approval, Interest Rates, Repayment. (n.d.). Retrieved from https://www.edvisors.com/college-loans/federal/parent-plus/introduction-to-federal-parent-plus-loans/
Perkins Loans. (2018, August 13). Retrieved from https://studentaid.ed.gov/sa/types/loans/perkins
Student Loan Debt Statistics 2018. (n.d.). Retrieved from https://studentloans.net/student-loan-debt-statistics/
Subsidized and Unsubsidized Loans. (2018, September 18). Retrieved from https://studentaid.ed.gov/sa/types/loans/subsidized-unsubsidized#subsidized-vs-unsubsidized