Tuesday, March 27, 2012

Average College Student, Average Loan

There are two kinds of news stories about student loans. One group of stories emphasize the huge total of student loans. Calculations from the New York Fed for the end of 2011 find: " The outstanding student loan balance now stands at about $870 billion, surpassing the total credit card balance ($693 billion) and the total auto loan balance ($730 billion)." The Student Debt Loan Clock, which for illustrative purposes continually updates the total student loan debt outstanding, is on the verge of crossing $1 trillion.

The second group of stories emphasize the problems of particular students who have large loans and great difficulties in paying them back. For example, this New York Times story tells of a New York University graduate (class of 2005) who took out more than $100,000 in loans while completing an interdisciplinary major in religious and women's studies. By 2010, she was earning $22/hour working as a photographer's assistant--and going to night school so that she could defer the loan payments.

However, neither counting the great mass of student loans nor revisiting the extreme cases of those who have overborrowed offers much guidance for average students wondering whether they should take out the average loan. Sometimes student loans pay off; sometimes not. What facts and concerns should the average student thinking about such loans be keeping in mind?  Christopher Avery and Sarah Turner tackle this question in "Student Loans: Do College Students Borrow Too Much—Or Not Enough?" in the Winter 2012 issue of my own Journal of Economic Perspectives. Here are some of the issues raised in their discussion:

Most students are borrowing amounts that are within standard loan guidelines
"Leaving aside extreme cases, are student borrowing levels assumed by the majority of undergraduate students consistent with their capacity to repay these loans? There is little evidence to suggest that the average burden of loan repayment relative to income has increased in recent years. The most commonly referenced benchmark is that a repayment to gross income ratio of 8 percent, which is derived broadly from mortgage underwriting, is “manageable” while other analysis such as a 2003 GAO study set the benchmark at 10 percent. To put this in perspective, an individual with $20,000 in student loans could expect a monthly payment of about $212, assuming a ten-year repayment period. In order for this payment to accrue to 10 percent of income, the student would need an annual income of about $25,456, which is certainly within the range of expected early-career wages for college graduates. Overall, the mean ratio of student loan payments to income among borrowers has held steady at between 9 and 11 percent, even as loan levels have increased over time ..."

My own guess is that part of what is happening here is that larger loan burdens are being offset by lower interest rates, so the overall ratio of loan payments to income has risen by less than one might otherwise expect. 

The median level of student borrowing isn't excessively high.
"Borrowing among students at the median is relatively modest: zero for students beginning at
community colleges, $6,000 for students at four-year public colleges, and $11,500 for students at private nonprofit colleges. Even at the 90th percentile, student borrowing does not exceed $40,000 outside of the for-profit sector. Examples of students who complete their undergraduate degree with more than $100,000 in debt are clearly rare: outside of the for-profit sector, less than 0.5 percent of students who received BA degrees within six years had accumulated more than $100,000 in student debt. The 90th percentile of degree recipients starting at for-profits have $100,000 in debt; so a nontrivial number of students at for-profits accumulate this much debt, but the situation is still far from the norm."

Students thinking about loans should also think seriously about their risk of not finishing a degree--especially at for-profit and less selective institutions.
"Only 55 percent of dependent students who anticipate completing a BA degree actually do so within six years of graduating high school, while more than one-third of them do not complete any postsecondary degree within six years. Similarly, more than half of dependent students who anticipate completing an associate’s degree do not do so within six years of graduating high school ... [A]among students beginning at four-year colleges, private for-profit colleges have dramatically lower average graduation rates (16 percent) for dependent students than do public (63 percent) or private not-for-profit (68 percent) colleges. In addition, there is substantial variation in graduation rates within each
college category, with more-selective colleges typically having higher graduation rates."
What are the average employment and wage prospects for your planned major?

Students considering loans should think about the typical employment and pay prospects for that major. 
I do think that many students agonize a little too much over their major, while not agonizing enough over the extent to which they are building a skill set. That said, different majors have different payoffs.
Avery and Turner offer some evidence on this point, and in this post of January 11, 2012, I discuss some basic evidence on "For What Majors Does College Pay Off?" In that post, I summarized it this way: "[W]hen looking at unemployment rates, along with the architects, those who  majored in humanities or in in the arts have relatively high rates, while those who had majored in health and education had relatively low unemployment rates. When it comes to income, the highest income levels are for those who majored engineering, computer science/mathematics, life sciences, social sciences, and business. The lower income went to those majoring in arts, education, and psychology/social work.

Students considering loans should consider that any major leads to a widely dispersed range of employment and pay outcomes.
When you look at pay out of college, there is considerable inequality--and the range of inequality has been generally increasing over the last couple of decades. Thus, the median pay is a better guide to expectations than the average. Especially if you have been a middle-range or lower-middle-range student all through high school, it would be unwise to assume that you are likely to be at the top of the income range after graduation.

Students should look to their high school experience for some guidance as to how they will fare in college. 

About 60% of high school students go on to college. For the purposes of a quick-and-dirty estimate, let's say that it's the top 60% by academic qualifications. Thus, if you are at, say, the 70th percentile of your high school class, you are in the middle of those going on to college. Given that many of those who go on to college don't finish a degree, being at the 70th percentile of your high school class may mean that you can expect to be ranked in the bottom quarter of those who complete a college degree. Sure, some students will improve dramatically from high school to college, but it's a statistical fact that half of college graduates will be below the median, and one-fourth will be in the bottom quarter, and especially if you are advising a large number of high school students, it's unrealistic to tell each of them that that they can all end up in the upper part of the college distribution.

Some students borrow too little: for example, they don't take advantage of the the subsidy implicit in the student loans for which they are eligible, or they run large credit-card debts when it would be much cheaper to use student loans to borrow.
"[O]ne in six full-time students at four-year institutions who are eligible for student loans do not take up such loans—thus forgoing the subsidy ... Another possible sign of the underuse of student loans is that a number of students are carrying more-expensive credit card debt when they could instead be borrowing through student loans. Among students who entered college in 2004, 25.5 percent of those who were still enrolled in 2006 and 37.7 percent of those who were still enrolled in 2009 reported that they had credit card debt. But between one-third and one-half of these students (45.6 percent of students with credit card debt in 2006 and 38.5 percent of students with credit card debt in 2009) had
not borrowed from the Stafford loan program. Carrying credit card debt without maximizing Stafford borrowing burdens students with unnecessarily inflated interest rates—a choice that can interfere with a student’s ability to finish a degree." In addition, there are a number of students working more than 20 hours per week, and at least some of them might have a better chance of finishing their degree if they borrowed more and didn't try to work many hours.

Clearly, some of this advice would, if taken seriously, discourage some students from taking out loans to attend college. Given the price of higher education, I think that hard choice needs to be faced. Several decades ago, it was a low-risk option to spend a few years working part-time and attending a big public university: if it didn't end up in a degree, at least you didn't rack up much or perhaps anything at all in loans and you could learn something and have a good time and grow up a little along the way. But at current prices, that part-time job won't pay the higher education bills at most institutions. Sending a message that all students should try a few years of college, even if it requires taking on tens of thousands of dollars in loans, is borderline irresponsible.

Before students take on a heavy weight of loan burdens that could loom over their financial life for several decades, they need to confront some legitimate questions:
  • Are you attending a college--especially a for-profit--with a high drop-out rate?
  • Are you planning on a major (or a set of classes that will build real skills) so that you have good employment prospects?
  • How strong is your personal motivation for attending classes and finishing a degree?
  • Does your high school class ranking give you reason to believe that you have the ability to succeed?
  • If your higher education experience doesn't turn out as you hope, and you don't finish the degree, or you don't end up with a job that pays substantially less with the median in your field, will you feel OK with the loans you have taken out?
  • Are you taking out an average amount of loans, so that you will be committing no more than about 10% of your income to repaying them? 
Given the growing wage gap between those with a college degree and those without, it will make economic sense for lots of students to borrow, especially at today's rock-bottom interest rates. But with student loans, we're talking about young adults often in their late teens and early 20s making financial decisions that could be with them for decades to come. It's a transaction that should be made with caution and consideration.