How much does college debt affect someone

Student Loans in the US - The Next Bubble?

For the first time ever, Americans have more student loans outstanding than their credit card debt. Comparisons with the real estate crisis are already being conjured up. Income-related repayment could bring relief.

"Michelle and I only paid back our last student loan eight years ago," says American President Barack Obama. After all, the investments have paid off for him and his wife. In the USA, in contrast to Switzerland, students bear a large part of the costs of studying themselves. Young families in particular are groaning when the loans are repaid. At the age of forty, parents often have debts from their own student days. But that's when they should actually start putting money aside for their children's education. This is advisable because tuition fees have been growing unchecked for years. According to the think tank American Enterprise Institute in 1980, the average annual teaching fees only made up 11% of the average American salary. However, by 2010 this proportion rose to 26%. It is not that Washington has been inactive - on the contrary. The state helps with grants, tax credits and loans. Washington made $ 169 billion available for this in 2010 - five times more in real terms than in 1987.

Grants for the middle class

In the USA, state support is primarily based on promoting equal opportunities. Access to college should be kept open to young adults from poor families. Pell grants are particularly useful for this. These are grants that have a maximum of $ 5,550 per year per student and are non-repayable. Andrew Gillen, economist at the American Council of Trustees and Alumni think tank in Washington, considers this form of support to be successful. He mentions that in 1970 only 46% of high school graduates from families in the lowest quarter of the income distribution attended college. By 2009 this proportion had risen to 59%. This is still well below the rate of 90% for high school leavers who come from the best-off neighborhood. However, the difference only has to do with financial hurdles to a very limited extent, says Gillen. Rather, high school graduates in poor areas are often completely insufficiently prepared for college. This is where the main evil lies and not the lack of financial support.

Under President Obama, the Pell Grant program was greatly expanded, which the government has hailed as a great success. According to the John William Pope Center for Higher Education, more than half of students now receive such grants. This means that the aid has long since reached beyond the group of the poor, which has greatly increased the program costs. Gillen sees a second deficit in the fact that the grants are paid regardless of academic success. But only 51% of Pell Grant recipients who started their studies in 2003 had a bachelor's degree six years later. Gillen therefore suggests that students should only be entitled to the full subsidy in the first year. In the following years they would have to show that they have reached certain academic milestones in order to receive any more money.

In addition to promoting equal opportunities, there is a second argument that could legitimize a state role. If someone builds a house and takes out a mortgage, they can secure it with the property. If the customer can no longer service the loan, the house falls to the bank. This security reduces the interest rate. Now imagine an 18-year-old high school graduate: If he goes to a bank, he has no credit history and will not be able to provide any security, as the knowledge he acquires in college is tied to himself. The result would be that very high student loan interest rates could deter (too) many young people from studying.

How could this problem be solved? The late economist Milton Friedman sketched a model in 1955. A student bequeaths a certain percentage of his future income (above the subsistence level) to the creditor - most likely the state for reasons of practicality - and receives a loan in return. The percentage would be set so that the program would be self-sustaining. The repayment would be processed via the income tax return, which would keep the administrative costs of such a human capital contract low.

Balance risks

Friedman's model, however, is not without its flaws. So those who have above-average skills should avoid it. Because the “good risks” would pay an amount over their lives that would far exceed their study costs - think of Mick Jagger, who briefly studied at the London School of Economics. For Friedman's model to work, however, “good risks” would have to offset the losses against “bad risks” whose income is insufficient to pay off the debt. Attempts by individual universities such as Yale University in New Haven to implement Friedman's model have not worked. Today, therefore, the focus is on a form of income-related repayment in which there is no balance between good and bad risks. Rather, everyone gives up part of their income until they have paid off their own debts.

«Arms race» of the colleges

The US has taken a different path to defuse the problem of high interest rates. Students from families with incomes less than $ 50,000 receive subsidized Stafford Loans. The interest is only 3.4% and is also not calculated during the period of study. All other students can receive “unsubsidized” Stafford Loans at 6.8%. A maximum of $ 31,000 can be borrowed from the state, of which a maximum of $ 23,000 can be subsidized. The debt has to be paid off over ten years.

Student loan debt has now risen sharply in the United States. It now amounts to over 1 trillion. $. This amount is higher than the total of all consumer loans. There are several reasons behind this development. First, far more Americans are taking up college today than they used to be. At the end of the 1970s, only one in four people in the 18- to 24-year-old age group went to college. Second, debt has risen because tuition fees have tripled in real terms since 1987. Some economists argue that the state expansion of loans and Pell Grants has given colleges scope for price increases. State funding up to the middle class contributed to the "arms race" among the colleges, in which they vied for the students' favor with comfortable accommodation, fitness rooms, swimming pools and climbing walls. In addition, the member states are providing the higher education system with less money due to empty coffers.

But neither should one dramatize the situation. An evaluation by the College Board shows that three-quarters of all Bachelor's graduates have taken out loans for less than $ 25,000, with one-third of all graduates having no debts after graduation. On average, those 25-34 year olds with a bachelor's degree make $ 45,000 a year compared to $ 30,000 for those who only get through high school. The debt burden thus seems manageable for most. However, 10% of graduate students have debts in excess of $ 39,000. For such young people, and especially for those who do not pass the diploma, the burdens are often too high, especially in the first few years after graduation, because the starting salaries are low. In any case, the risk of bankruptcy has increased significantly.

Obama is silent about costs

This group could benefit from income-related repayment benefits. The government already offers such an option for loans granted by it: This can be used if the burden on a debtor exceeds 15% of the available income. The debtor then pays 15% until the debt is repaid, but for a maximum of 25 years. If everything is not paid back, the rest will be waived. The possibility has hardly been used so far. It is little known and the bureaucratic hurdles to use it are high.

President Obama wants to change that. At the same time, he ordered additional discharge by decree. From the current year onwards, the student has to deliver a maximum of 10% of the income, and the remaining debt is canceled after twenty years. What is shocking, however, is that government employees and employees of non-profit organizations are privileged: With them, the remaining debts are canceled after ten years, although this regulation was introduced in 2007 and thus in the Bush era. It is also annoying that the government is silent about the costs that will arise if - as planned - 1.6 million students are to be drawn into this regime in the future and thus the remaining debt is waived much more often than before.

Interest as the plaything of politics

A major disadvantage of government student funding in the US is that interest rates are politically determined. In contrast, financial institutions would consider a number of factors when determining the interest rate for a person, such as high school diploma, choice of subjects, quality of university, or income prospects. The student is then confronted with the costs of choosing a subject. In contrast, the conditions in a state system are the same for everyone.

The economist Gillen therefore recommends that not the state, but the private sector should grant student loans. But isn't there another danger that students will find it difficult to get loans due to a lack of collateral? For this reason, his model envisages that a borrower who can no longer meet his obligations automatically switches to an income-based repayment. The banks would voluntarily decide whether to participate in this two-tier model. If they agree, the state will help them collect the income-related repayment. The state would also set a maximum that the student could borrow in order not to fuel the "arms race" of the colleges. And it would determine the conditions under which a person would be considered insolvent and could switch to income-related repayment. There are no subsidies. However, it remains to be seen whether banks would accept this model - Friedman had already wondered why the banks did not offer models with income-related repayment of their own free will.

Which way for Switzerland?

If the state wants income-related repayment, it must determine four parameters: the maximum loan amount, the percentage of the income to be paid, the maximum repayment period and the interest. In addition, it is important to decide whether the loans will be subsidized or not. The transition to an income-based repayment would be particularly appropriate for countries like Switzerland or Germany, where the students have so far only contributed very little to the costs. In any case, Australia has had positive experiences when it switched from “free studies” to this concept in 1989. In Switzerland, the universities are still largely funded by tax revenues: the auto mechanic uses it to finance the training of the offspring of his Mercedes customers. A university degree benefits those who acquire it in advance, which speaks against paying for the university education largely from tax revenues. Moving to student loans with income-related repayment would reduce this bottom-up redistribution. If this were combined with grants to the poorest, their access to the university would continue to be guaranteed.