Student Loans and the Effect Student Debt has on The Economy

Background

In the recent years, loans taken by higher education student has increased to enormous amounts. A survey done by the Federal Reserve Bank indicated that in 2016, the total debt increased to four times the figure recorded in 2004 (Gin, 2017). Towards the end of 2016, 1.31 trillion dollars had been borrowed to fund various university and college courses. When the education debt is compared to others in the country, it ranks among the highest debt sources in the economy. Currently, only the mortgage debt with a value of $8.69 trillion is more than higher education borrowing, but credit cards (764 billion dollars) and loans for home equity (452 billion) are surprisingly lower despite the fact that they have a broader population base. A narrow segment of the country’s population is affected by the debt as it is only accessible to people who have enrolled in institutions of higher education. Therefore, the unpaid loans per student are above $30,000 which is higher than for both home equity and credit card loans.

Citizens of all income categories access student loans. However, if a large percentage of the loaned individuals were from high-income families, then the dragging effect on the economy would be minimal. It is estimated that over 70% of bachelor’s degree graduates from public institutions have problems with the repayment of the accrued debt. The academic situation is getting worse as institutions that provide grants towards learning are unable to cope with the increasing tuition fees. Consequently, low- income households opt to take loans to finance their education. Research conducted by the US Department of Education revealed that about 44% of undergraduates who still depended on a family income of less than $30,000 had not paid more than $12,400 student debt (Freedman, 2014). Additionally, 50% of students in middle-income families whose income bracket ranged between 30,000 and 106,000 dollars had a debt of above $ 12,000. Therefore, the level of debt in the country increases per year because there is no balance between loan taking and repayment.

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Reduction of the Purchasing Power

The idea that education loans affect household purchasing power appears to be plausible. The economy is likely to experience more harm in the future if more graduates default in their contributions towards the repayment of debts. Due to the availability of funding, institutions of higher learning have been increasing their tuition fees which have increased the cost of education beyond the current loan limits. A vicious cycle is created which further deepens the students’ need for more loans to cater for the increased expenses (Freedman, 2014). Additionally, state investment levels have dramatically reduced, thereby exposing students to more risks.

Reduced Spending

After graduation, many students decide to spend less because they cannot afford to purchase products that they would like to possess. According to a survey conducted in 2015, almost a half of the student borrowers do not consider buying a car after graduation (Kirkham, 2016). Also, the study concluded that fewer shopper visit retail or point of sale businesses as 33% of the shoppers would cut their holiday spending because of the debt. The US is mostly a consumer-driven economy, and private enterprises depend on the purchase of goods and services to generate revenue. College and university graduates make a significant percentage of the target market for many small, medium and large businesses. If this segment of the population reduces their spending, then many firms would have to minimize their scale of operation which would, in turn, show financial growth.

The older generation forms an essential market for many sectors of the economy. Most of the senior citizens are pensionable which increases their purchasing power as many would spend what they have rather than save as they are in the last stages of their lives. Recent graduates do not prioritize the contributions towards a retirement benefit as the student loans limits their ability to cater for both schemes. Those who enroll in retirement benefit plans pay low premiums (Gin, 2017). According to the compound interest calculations, it is evident that the lack of contribution towards a retirement plan early in life results in the reduction of the total amount saved which consequently minimizes spending decades later when one reaches his retirement age. The low savings affect the purchasing power of the students when they are at an old age.

Slows the Real-Estate Market

Buying a home is one of the most popular decisions for new graduates who are beginning to build their lives after completing school. Instead of saving to buy a house, student loan borrowers would instead service their loans as the interest rates affect the final amount which is a summation of the base pay and the interests. Studies have indicated that about 41% of borrowers delay home ownership while 27% have not managed to secure a house or even purchase an apartment (Kirkham, 2016).The mortgage market is directly affected by home-buying. Real-estate investment companies and banks generate millions of dollars from the interests obtained from loaning their customers. Many students would not consider taking another loan while there is another one that needs servicing. Therefore, the revenue generation has gradually been diminishing such that the construction of new real-estate properties has been on a downward trend.

Holding Back New Enterprises

A growing economy is sustained by the establishment of new startups which diversify the generation of services and goods. A study conducted by the Federal Reserve Bank of Philadelphia suggests that fewer businesses are created due to the increase in student debts. According to a survey done by Gallup-Perdue Index in 2015 on recently graduated individuals, 1 in 5 respondents said that the accumulated student loans held them back from exploring their entrepreneurial desires (Kirkham, 2016). In the same research, it was determined that 25% of the borrowers with loans which surpass $25,000 delay their ambitions of starting a new enterprise because of the unpaid student loan (Gleeson, 2016). Moreover, it is difficult to access a start-up capital as banks, and other lenders would most likely make it harder for one to obtain a loan if the student debt has not been serviced. Therefore, the debt reduces the expansion of a country’s economy and slows productivity.

Loan repayment diminishes or eliminates the purchasing power of citizens and reduces the disposable income. According to Cleveland’s Federal Reserve Bank, the rate of loan repayment is less than $400 per month (Kirkham, 2016). It is evident that an individual who is contributing towards the repayment of his education debt faces challenges in accumulating capital which can be used to explore entrepreneurial options. Most startups require owners’ equity as the small scale of the business and available assets limits its access to bank loans. Many lenders would not risk allocating financial aid to small-sized firms which do not have sufficient collateral (Gleeson, 2016). Consequently, innovative minds who have been the backbone of the American economy encounter many challenges, thereby killing their business ideas before they get a chance to develop into successful enterprises. For instance, large companies such as Google, Facebook and Microsoft have been acquiring many startups due to their unlimited financial resources thereby diminishing economic expansion. Most of the new enterprises are owned by college and university students who despite the pressures of loan repayment manage to fulfill their entrepreneurial wishes. The financial payout in this acquisitions is usually a significant amount, thereby enticing the owners of the business to sell in an attempt to gain financial compensation.

Potential Future Effects of Student Loans on the Economy

In 2008, the USA suffered a massive financial crisis, which began as a result of issues in the subprime mortgage segment. Many Americans took high-risk loans to finance the acquisition of homes leading to the increase of housing prices that ultimately led to the collapse of the real-estate market as individuals borrowed against their built properties (Nitz, 2017). Eventually, the stock market and a section of the financial institutions fell thereby resulting in high unemployment. Experts suggest that the next economic downfall may be caused by the increasing student loans as it has economic repercussions that are similar to the housing “bubble” that led to the financial turmoil.

According to an article in the Financial Times, the cost of education has been increasing at a high rate which has made it harder for people to pay tuition fees (Nitz, 2017). Many opt to take a loan that eventually supersedes their capacity to pay monthly contributions towards the repayment of the debt. The media article further indicates that the United States student debt has increased by 170% in the last ten years. Additionally, out of the 44 million students with financial liabilities, a total of 8 million have defaulted after failing to pay per the agreed time. According to Bloomberg, the economic situation has adverse effects on the economy as it delays entrepreneurial progress because people are not in a hurry to spend the minimal financial resources.

The Chicago Tribune suggests that although the current student debt problems have damaged the American economy, it is unlikely that its effects will result in a recession similar to the 2008 housing crisis (Nitz, 2017). When the housing “bubble” collapsed, it was estimated that about 66% of the gross domestic product (GDP) was made up of mortgage debt. On the other hand, education makes up less than 10% of the GDP. Additionally, the average mortgage debt in 2007 was 300,000 dollars compared to the current median loan debt of $13,000. Therefore, despite the current problems brought by student borrowing, the US would not necessarily suffer another recession attributed to education debt.

Advantages of Student Loans

Education is increasingly becoming expensive, and many low and middle-income households are not able to pay tuition fees for their children. However, student loans enable such individuals to access higher education which increases their education level, thereby improving the country’s human capital (Nitz, 2017). The United States economy largely depends on technology where firms such as Google, Microsoft, and Apple have grown because of the highly skilled workforce from institutions of higher education. In fact, the co-founders of Google LLC Sergey Brin and Larry Page were pursuing a Ph.D. when they started the company which has provided more than 50,000 jobs worldwide. Therefore a skilled workforce has the potential of improving the economy. Additionally, a wealth of knowledge is obtained when taking out loans, thereby increasing the human capital which enhances the productivity of the labor market.

 

References

Freedman, J. (2014, February 11). Student Loans Are A Drag On The Economy And Society. Retrieved from Forbes: https://www.forbes.com/sites/joshfreedman/2014/02/11/student-loans-are-a-big-drag-on-the-economy-and-society/#5a19d6a74bc1

Gin, A. (2017, September 22). Student loan debt doesn’t just hurt students. It hurts the U.S. economy, too. Retrieved from The San Diego Union- Tribune: http://www.sandiegouniontribune.com/opinion/commentary/sd-utbg-student-loan-crisis-fix-20170922-story.html

Gleeson, M. (2016). Student loan debt and the effects on the broader economy. Baltimore: John Hopkins University.

Kirkham, E. (2016, December 6). 6 Ways Your Student Debt Ultimately Hurts (and Helps) the Economy. Retrieved from Student Loan Hero: https://studentloanhero.com/featured/effects-of-student-loan-debt-us-economy/

Nitz , S. (2017, June 30). How Does Student Loan Debt Affect the Economy? Retrieved from NFCC: http://www.studentloanhelp.org/articles/how-does-student-loan-debt-affect-the-economy/

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