Between 1993 and 2011, the years I was born and entered college, the average college tuition appreciated 165%. This rate was more than triple broad inflation over the same period of time, and more than one-and-a-half times greater than the increase in health-care costs. During this time, it’s become easier for college students to get access to credit – students can now take out a student loan without a credit check or a co-signer. Unsurprisingly, student debt is now nearly $1 trillion, more than three times what it was just a decade ago.
Considering that tuition has nearly doubled, the proliferation of student loan options, and the potential for disastrous effects on the economy, it’s easy to use the C-word when referring to the current situation: crisis. The reason some believe the situation is a crisis is because federal student loans are backed by the government. If a student defaults on his or her federal loan, the government is on the hook for the remainder of the balance. When the government is on the hook, the debt usually gets pushed on to the taxpayers, who end up footing the bill through higher taxes and higher interest rates. Not good.
So what makes the student loan market so broken? Following the financial crisis in 2008, governments began directly lending to students. However, they offered only one interest rate for all students, regardless of their credit. Students with high credit would get the same rate as students with low credit.
Even though the student loan situation might be a crisis, I’d like to point out a few things that might indicate otherwise with the help of two CEO’s trying to solve this problem: CommonBond’s David Klein and SoFi’s Mike Cagney.
4 REASONS FOR THE GROWING STUDENT LOAN PROBLEM
1. Private, For-Profit Universities
Half of the student loan delinquencies can be attributed to one source: private, for-profit universities. Delinquencies refer to payments that are over 90 days late; currently, almost 11% of student loans are considered delinquent. According to the Department of Education, approximately 10% of college students are enrolled in for-profit institutions. These universities are notorious for falsifying job-placement statistics, true cost-of-education numbers, and are generally more interested in jacking up enrollment numbers to receive federal funds than providing quality education and career services. In a vacuum, for-profit universities such as the University of Phoenix and ITT Technical Institute might be doing more harm than good.
Says Klein, “[Private for-profit institutions] market their programs with promises of placing their graduating students into ‘gainful employment,’ but in many cases, the data does not prove that out. In fact, 72% of for-profit programs produce graduates earning less than high school dropouts earn, according to Education Secretary Arne Duncan in March of this year.”
That’s incredibly scary – pay college tuition fees with the hope of getting a solid job, and end up earning less than a high school dropout? What’s worse is that these for-profit institutions receive the majority of federal funding.
“Up to 90% of private for-profit schools’ funding can come from the federal government. Some call this the ‘90/10 Rule.’ Private for-profit schools collect about $30 Billion annually from the federal government through the 90/10 Rule” adds Klein.
Private universities such as Stanford and Harvard are educational and research nonprofit organizations. Public universities, such as UC-Berkeley, receive state support to help fund expenses, but are similarly nonprofits. The key difference between for-profit and nonprofit universities is that for-profit universities have shareholders and are part of a larger private company or corporation. As a result, they have come under fire about their tactics in attracting students, questionable education quality, and poor job placement.
2. The Pursuit of Graduate-Level Education
Though the average debt has surged to $23,000 per student, the median debt per borrower is much lower, at around $14,000. The data seems to be skewed by a small percentage of students borrowing in the six-figures in highly specialized fields such as business, law, and medicine. About 3.6% of students borrow more than $100,000, while nearly 40% borrow less than $10,000. Though the trend persists that students today are borrowing more than they ever have, this average is getting pushed up by students who are pursuing more expensive students, putting them in the minority.
The Brookings Institute published a study titled “Is A Student Loan Crisis on the Horizon?” that examined the relationship between college tuition and student debt levels. One of their key findings was that approximately one-quarter of the increase in student debt since 1989 can be directly attributed to the pursuit of additional education, primarily in graduate departments. Since 1989, debt levels of students with graduate degrees quadrupled from $10,000 to $40,000, while undergraduate debt levels increased from $6,000 to $16,000.
3. One-Size-Fits-All Federal Loans
The federal government’s method of pricing student loans is becoming obsolete thanks to private companies such as CommonBond and SoFi.
“Pricing risk is not the government’s forte. They didn’t price loan rates according to risk and still haven’t: every student borrower still gets one rate,” says Klein. “That’s in large part why the student loan market remains broken, while other parts of the financial system seem to have gotten back onto their feet a bit more since the crisis.”
Adds Cagney, “If you’re coming out, you have a good job, have plenty of free cash flow, there’s absolutely no reason in the world that you should be paying a 7.9% loan rate, there’s significantly lower options for you, and we try to facilitate that.”
Both CommonBond and SoFi have extensive graduate re-financing programs to address the growing student debt numbers built on an interesting premise: connect alumni investors to students looking to finance their education to build a sense of community and strengthen community relationships. CommonBond began at the Wharton Business School and has expanded to over 100 programs nationwide across graduate business schools, law schools, medical schools, and engineering programs. SoFi started at the Stanford Graduate School of Business, and can now be found at more than 2200 schools nationwide.
SoFi has found the re-financing market to be particularly attractive because it brings out the best of the community.
“When we have a borrower that loses their job, we put them in economic hardship forbearance, and then we actually have two full-time recruiters who can go out and get them re-employed,” says Cagney. “That’s a feature of the SoFi community, but those recruiters are going to alumni investors and the other folks in that community and getting leads and getting people employed through those channels.”
4. Students Loans – Good or Bad Debt?
Student loans are often misconceived as “bad” debt. But how can this be? “Good” debt is viewed as an obligation that allows you to generate wealth at some point in the future. The best example of this is your mortgage. By making your mortgage payments, you continue to build an equity stake in your home that could either result in a bigger stake should you choose to sell or outright ownership. (Related: Why Gen Y Can No Longer Afford Prime Real Estate)
The classic examples of “bad” debt are car loans and credit-card debt. Cars depreciate the moment you drive it off the lot, and it’s just about guaranteed that you’ll end up selling for a loss. Credit-card debt can often be misused to purchase disposable goods, such as groceries, and people are often too unorganized to continually make payments in full. As a result, credit card bills can continue to grow due to compound interest. (Related: 5 Reasons Why You’ll Never Be Rich And One Reason Why You Already Are)
Student loans, on the other hand, allow you to generate wealth by providing you with the education to start your career and introducing you to people that allow you to build your network. The Brookings Institute found that annual incomes kept sufficient pace with rising debt levels to mitigate any cause for concern. Between 1992 and 2010, annual incomes for households with student debt increased by $7,400, while debt appreciated $18,000. Based on these numbers, students would be able to pay off their additional debt within two-and-a-half years.
Though two-and-a-half years is a significant amount of time, there is evidence that demonstrates the monthly burden for student debt borrowers has declined over the past twenty years. Since 1992, the median borrower has allocated approximately three to four percent of their monthly income towards paying down their student debt, but during this time the mean payment-to-income rate has been cut by more than half, from 15% to 7%.
One cool feature offered by SoFi is their Entrepreneur Program. Cagney found that recent grads often pointed to massive student loan burdens as the primary reason for why they were unable to begin their own ventures. To address this problem, SoFi began the Entrepreneur Program, allowing up to six months of payment deferment so that entrepreneurs could focus on building out their business. Additionally, the social component of SoFi has allowed entrepreneurs to access their network for industry connections, seed capital, and director and advisory roles. To date, 19 entrepreneurs have taken advantage of this opportunity. The Entrepreneur Program is an interesting private sector feature that demonstrates why student debt can be turned into a building block of wealth.
NOT ALL IS BAD
I can understand why people might be fearful when they hear “debt” and “$1 trillion” in the same sentence. But there are a few key aspects to consider when evaluating whether the student loan crisis is a crisis, or even a bubble. Student debt is a better form of debt – it allows individuals to build skills that enable them to become employed and enjoy an income. Though student debt has increased over the past few decades, so too has income, with earnings for a bachelor’s degree growing by 75% compared to debt at 50% over the last 30 years.
Furthermore, the increase in students financing graduate school education with debt represents an inherently good thing: they value and desire to attain the highly specialized skills that translate to the workplace, which is great for the American economy. Some might argue that the potential short-term liability on American taxpayers outweighs these economic benefits in the long-term. To this point, I would point out that the monthly burden on student loan borrowers is half what it was just two decades ago and the growth of the private student loan industry provides attractive alternatives to students, reducing taxpayers exposure to this liability.
It will be interesting to watch the role public policy, private companies, and universities play in the student loan arena in the coming years.