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The effect of student loans on your future: What to know before applying for financial aid

The student debt crisis starts with insufficient education and information. Colleges and the government should address it.
Image: College friends study together
College friends study togetherSteve Debenport / Getty Images

In 2019, more high school graduates than ever will be heading to college — which is the good news.

But tuition costs are skyrocketing; the cost of college has increased more than sevenfold since 1983. Students are regularly taking more than four years to graduate. Students are taking out more and more in loans, both public and private, to cover the costs, and the federal government has reacted by ratcheting up the amount people can borrow.

And Washington already owns or guarantees $1.4 trillion in student loan debt to nearly 43 million borrowers.

In other words, America's trillion-dollar student debt load has many fathers. Resolving it will require everyone to work together to better educate student and parent borrowers about balancing aspirations with debt — and ensure that students graduate on time with the skills employers demand so they have any hope of paying it off.

The federal government, wittingly or not, has helped make universities' tuition hikes possible by subsidizing student debt — capping interest rates for undergraduate borrowers at 8.25 percent. In 2013, President Obama nearly cut undergraduate student loan interest rates in half by tying them to the financial markets.

The government also raised aggregate Perkins loan limits for undergraduate four-year college students from about $17,000 in 2006 to $27,000 in 2008. Aggregate subsidized Stafford loan limits for undergraduate dependents jumped from $17,250 in 1987 to $23,000 today. And undergraduates who are independent from their parents or whose parents don’t qualify for federal loans can borrow up to $57,000 in federal loans to fund their education. Private loans not subject to government restrictions only add to this potential burden.

Those may be understandable responses by policymakers to the rising cost of college. But, along with flourishing private student loan markets, they've fueled tuition inflation. More access to college funding from the government has emboldened colleges to hike up prices, since they know borrowers can rely on the government to meet costs.

Students have borrowed more in response — but paying off higher balances takes longer. Only 44 percent of borrowers have repaid at least one dollar of principal within three years of beginning their payments.

The massive debt burden — combined with a difficult job market for college grads — would increase the risks of default in normal circumstances. But, for those who don't graduate, that risk multiplies.

Just 59 percent of Americans finish a bachelor's degree program within six years at a public institution, and non-graduates are three times as likely to default. Many of these defaults are on relatively small debts: Two-thirds of defaulters owe less than $10,000. But a four-figure student loan could still haunt them for decades, in the form of lower wages once their payments are deducted and higher borrowing costs for other big purchases like cars and houses.

But both colleges and lenders know that students defaults often happen, in part, because students don't receive adequate information about what it will cost to earn their degree or what their monthly payments will be. That information is available for students who seek it out, but it's often not automatically provided as part of the loan application process.

One in five borrowers doesn't understand the terms of his loans, according to a recent study sponsored by George Washington University. Over half those surveyed had no idea what they'd owe every month when they took out their loan.

All students receiving federal loans are required to go through online counseling developed by the U.S. Department of Education. But 40 percent of those who used the counseling tool had no memory of it.

Student borrowers also tend not to know how much they'll make in their chosen field — and consequently, how easily they'll be able to pay their loans back. Yet the federal government generally funds studies in high-paying and low-paying fields on equal terms, as well as for schools with low and high graduation rates and low and high job placement rates.

Simply put, the student debt crisis is a problem of insufficient education and information. That's something colleges and the federal government should be well-equipped to address.

They can start by counseling students long before they sign on the dotted line — like when, to qualify for federal loans, borrowers fill out their Free Application for Federal Student Aid packages. Some borrowers discover too late that their choice of major or school isn't what they expected, or is beyond their means or comfort level. Intervening earlier with individually tailored advice could help students avoid accumulating debt before dropping out — or nudge them onto a different academic path.

Schools must also keep students informed about their debt while they're enrolled. Public colleges in Indiana, for instance, must send students an annual report on the amount they've borrowed, along with links to financial literacy resources. According to a study from the Federal Reserve, programs like these keep students focused on their academic goals and encourage them to borrow less.

In addition, the government can streamline the repayment process. Borrowers today have more than 50 options: If they wish to enroll in income-driven repayment plans, for instance, they have to complete lengthy applications on their own and loan servicers can't assist them. Even simple changes can yield vast improvements.

One pilot program provided borrowers pre-populated applications for income-driven repayment plans that all they had to do was sign. Almost 71 percent of those who participated returned the form within 10 days, and 27 percent of those who had to fill the forms out manually returned them within 60 days.

Finally, higher ed and government must make college completion a bigger priority. Schools should have some skin in the game, since they receive the proceeds of taxpayer-subsidized loans. Those whose graduation rates increase should be rewarded, and those who fail to help their students cross the finish line should be penalized.

A college degree remains the surest path to prosperity. Student loans should aid that pursuit, not impede it.