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Financial Illiteracy Exacerbates Student Loan Crisis

Michael P. Tremoglie

NEW YORK (MainStreet)—It seems that many students - and their parents - are wading into a miasma of college tuition financing they are ill-prepared to understand. All too anxious to start attending the college of their choice, indeed often the college of their dreams, students and parents know little about the terms of the loans they obtain for tuition.

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One would have thought somewhere in all the high school honors courses and all those science and math courses SOMEBODY would have mentioned the concept of compound interest. Yet, many high school graduates and college students do not seem to understand this theory as to credit cards and college loans for tuition.

When the Securities and Exchange Commission issued a report in 2011 about the financial literacy of the American public, it did so as a requirement of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. The report gauged investors' knowledge and needs.

What has not been studied is the financial illiteracy of those borrowing for college. It is an enormous amount of money that people are borrowing to invest in a future. Moreover, there is increasing evidence this investment does not seem to be worth the risk.

A report by the Consumer Financial Protection Bureau (CFPB) dated May 8 indicated there are various means by which student loan debt can be a bar to financial security for consumers. The report was derived from public input to the CFPB "for policymakers and market participants to consider in order to help borrowers manage their private student loan debt," according to the press release.

"College can open up many opportunities, and we do not want that college degree to become more of a burden than a blessing for those saddled with unmanageable debt in a tough employment market," the communiqué quoted CFPB Director Richard Cordray as saying. "Today's report warns of the potential domino effects on the economy of high student debt."

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This financial illiteracy is having a toxic effect on the larger economy as student indebtedness impedes their ability to purchase big-ticket items. For example, unable to shoulder more debt they postpone buying homes.

According to the CFPB, the National Association of Home Builders (NAHB) stated that higher student debt burdens "impair the ability of recent college graduates to qualify for a loan." According to NAHB, high student loan debt has an impact on consumers' debt-to-income (DTI) ratio– an important metric for decisions about creditworthiness in mortgage origination.

The CFPB also cited the National Association of Realtors (NAR) as claiming that since first-time homebuyers greatly depend on savings for down payments many borrowers have, "unmanageable student debt can make it difficult to accumulate any savings." According to the CFPB report, NAR data published states the first-time homebuyers' market share of existing homes was 30% in February 2013, compared to historical levels of 40%.

Not only is homeownership impacted but the CFPB alleges that student debt also "may have discrete impacts on American small business formation." According to comments they have received from consumers, "student debt may suppress risk-taking and innovation by discouraging the formation of new businesses by young entrepreneurs."

Indeed, the U.S. Small Business Administration's (SBA) website asks this question, "Is student loan debt stopping you from starting your own business? The Income-Based Repayment (IBR) Plan can help."

The SBA advises student borrowers to participate with the Income-Based Repayment Plan. This plan "supports young college grads, including those looking to start a business, join a startup, or work in a public service job by making Federal student loan repayment manageable. It can help you keep your loan payments affordable by using a sliding scale to determine how much you can afford to pay on your Federal loans—empowering you to take risks with new opportunities."

Student debt is also having a negative effect on older Americans. The American Association of Retired Persons (AARP) has advised parents not to co-sign student loans.

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A December 14, 2012 article on the AARP website said:

"Data from the Federal Reserve Bank of New York show a shocking trend: Americans 60 and older are now the fastest-growing owners of college debt. Student loan debt for this group has skyrocketed to $43 billion, more than fivefold since 2005, mainly because parents are cosigning for their children's college loans. Private student loans are the worst. They have higher interest rates and, unlike federal student loans, there are no provisions for forgiveness. Neither private nor federal student loans can be written off in bankruptcy court, so the debt absolutely must be repaid. Some seniors are paying student loans with their Social Security checks. Others are forced to cut expenses or live with their kids in old age. Avoid these scenarios by just saying no to cosigning student loans for others."

So, given the dire financial consequences of student loans and the all-too-willing attitude students and their parents have towards incurring this debt, what can be done?

Some urge educating the young in financial literacy. Politicians, advocacy groups and other policymakers proffer that increased financial education will lead to better financial outcomes for the consumer.

But at least some have declared financial education ineffective, like Lauren E. Willis, a professor of law at Loyola Law School in Los Angeles who has written several papers about financial education and consumer protection.

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A paper she presented in 2011 titled "Financial Education: Lessons Not Learned & Lessons Learned" concluded that there is "no strong empirical evidence (that) validates the theory that financial education leads to household well-being through the pathway of increasing literacy leading to improved behavior."

She recommends some alternative ideas such as providing financial advisers to people of all income levels. She believes that the search for financial education should be replaced by a search for policies more conducive to beneficial financial outcomes.

C. Claire Law, a Certified Educational Planner who helps students and parents access affordable education, is on the frontline of the education finance issue. She thinks more could be done to educate people about financial literacy.

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"Financial literacy starts in high school and even earlier," Law said. "Parents should use the FAFSA4caster to figure out their expected contribution and use the Net Price Calculator which every college is now mandated to post on their financial aid website to find out what they would pay. Students often seek out "name" colleges but instead need to seek out what fits them academically, socially and financially."

--Written by Michael P. Tremoglie for MainStreet

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