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Student Loans in America

Education is a valuable investment as it contributes positively to the development and performance of the economy. Attainment of sustainable growth in the economy is influenced by education. Investment in human capital will provide a workforce that is productive and, hence, the economy development. An educated workforce is required to support changes in the technological arena through researchers’ innovation and through adoption of knowledge that already exist. The benefits of education are unlimited as it generates a varied range of social benefits, such as unemployment rates that are low, better health, and low rates of crime. Education is an investment that is attractive to individuals in addition to earning high social returns. Private returns that emerge as a result of an additional year of schooling range from 5% to 15% and these returns are seen to increase in most countries due to such factors as technological change that is biased (Shipler 2005).

Production process involves education aspect for there to be increased productivity. Knowledge gain is essential in the development and performance of economies. In this aspect, higher education is vital in economic growth and may be regarded as the economic engine. Accessibility of higher education is a factor that influences the potential development and growth of the economy. In most low income states barriers to education deter economic growth. Limited access to higher education may be caused by imperfections in the credit market where students lack access to funds in financing their education. Interventions by the public with the aim of minimizing these imperfections in the market may act as a great boost to accessibility of education (United States 1999). This yields substantial returns and acts as an engine to fuel the growth of the economy through human capital creation. Problems in the credit market can be remedied by proper use of scarce resources within the public domain. Countries within America have developed programs that will offer students with education loan to improve efficiency in accessibility of education.

Mexico is one of the states that implemented a students’ loan program. This was fueled by the increasing demand for post secondary education and the public universities capacity within the state. Public universities in this state suffer budgetary restrictions and thus cannot accommodate many students. In this sense, many students demanding higher education result to the private universities that charge relatively high prices. This makes education less affordable especially to students from poor backgrounds. The private universities that are considered to be of high quality charge relatively high costs and students receive very minimal support from the government. A group constituting of 40 universities in the private sector instituted a program that offers loans to students that are talented academically and hail from poor backgrounds (Wilkinson 2005).  The program is selective in the sense that students who have collateral backing in accessing the loans are preferred. This program in Mexico gets a boost from the World Bank loan.

Most students in America associate financial success with higher education. In this sense, higher education has become essential both for the nation and individuals who hold their hopes in entering and remaining in the middle class. A well-educated workforce is required for creation of extra opportunities within the United States. This will also assist the country to remain highly competitive in the international arena. However, incomes of many families and the state of investment do not allow easy access to education as education becomes less affordable. This creates a gap between students from wealthy backgrounds and those from poor backgrounds.

Families and students who hail from poor backgrounds have shifted their focus to student loans to try and bridge the gap in the affordability of higher education.

Currently, workers and students seeking education make use of extra ordinary borrowings from loan programs in an effort to finance their education. Certain programs like the private loan program and the federal loan program have been initiated with the objective of making education affordable. Students making use of these programs can meet the cost of their education. Students who graduated in 2010 owed an average of $25,250 per person in loans. There was about a 5% increase as compared to the previous year as according to the report given by the student debt project at the Institute for College Access & Success (TICAS). In aggregate terms, the total amount owed on loans amounted to $100 billion in 2010 for the first time (Finifter & Hauptman 1994). The total outstanding loans by 2011 was above $1 trillion, and it was the highest loan amount to be recorded Americans owe less on their credit cards as compared to the student loans. This implies an increasing trend in borrowing for education purposes. This adds to the burden that students have in the future when it comes to the repayment of the student loans.

The existence of a tough economy within America has forced people to seek higher education with the objective of becoming more competitive and thus securing jobs. Since most students and workers cannot afford the cost of education, they start borrowing to finance their education. This increases the burden the students have and the obligation they have in repayment of their loans in the future. Borrowing for education is designated for all individuals in all age brackets. However, most of the borrowers in this scheme fall within the age bracket of the young. This means that young people carry the biggest burden in terms of loan repayment within America. An increasing trend in education borrowing is seen among individuals between 35 to 49 years according to credit score analysis. There is an increase of 47% among individuals within this age group in terms of education borrowing (Volunteers in Service to America 1992).

Education borrowing has also attracted interest from parents who are seen to be borrowing at record rates in line with students. Parents borrow loans to finance their children education and the rate has jumped to 75% since year 2005. Parents’ loans backed by the federal loan amount to about 10% of the total outstanding education loans.

The increasing rate of borrowing results to an increasing burden on the borrower. This results to increased risk both to the borrower and the economy, hence, to the poor performance of individuals and the economy. Investment in college education is considered to bring lucrative outcomes which are contrary to the truth. This is because investment in education may not necessarily guarantee the highest paying jobs or a situation that is free from financial difficulties. Even in situations when the economy is performing well, young people are observed to delay in the cycle of their life. Young people are observed to delay in such events as marriage, bringing up children, purchasing a home, and even buying a car. This is attributed to the burdens the students have in terms of education loan. The repayment of these loans makes the students delay their life cycle. The existence of minimal time to repay back the loan means the students can even retire without having completed loan repayment (Finegold, McFarland & Richardson 1993). This situation is even worse when it comes to the parents who borrow for their children. The burden created by the education loan may deter the students from accessing mortgage in the future or have difficulties in mortgage repayment.

The Institute of Higher Education Policy (IHEP) analyzed default rates and delinquency through studying 2002 class graduates after a period of five years since graduation. By examining those students who began repayment immediately after their graduation, 15% defaulted while 25% became delinquent. Other students within this category resulted to federal programs to seek refuge. These programs offer students an opportunity to postpone or minimize their payments. Students who honored their obligations constituted 40%. The default rate in the education loan is believed to be 20%. This concern is emphasized by various individuals within the economy. The experiences from the bankrupt attorneys record a similar situation of a crisis in the economy that was witnessed in the country. The situation experienced with the education loan schemes, and the default rate is expected to yield similar results of a crisis. The students are seeking help with unmanageable loan debt and with no relief available (Conner, Saab & Cicmanec 1997).

Foreclosure crisis fronted by the mortgage crisis is expected to resurface given the situation with students’ loans. The default on mortgage repayments resulted to the economic crisis. Similar effect on the general economy is expected with students not having the required resources to repay their loans. The general economy will suffer due to default on the loans repayment. Housing bubble resulted to the creation of a mortgage debt which absorbs the income of consumers. This makes the consumers unable to engage in customer spending, which is in addition to the economic performance results to no sustenance of economic growth. Education loan is also seen to produce the same effect on consumers using their incomes to finance their debt instead of engaging in the activities that contribute to the growth of the economy (Toby 2012). This trend will contribute to dragging the growth of the economy in the foreseeable future. Engaging in the life cycle like purchasing a home by these individuals is constrained by a lack of funding, since their income is directed to the repayment of loans.

United States was hit by a severe economic depression in 1929, and very few Americans could afford homes by 1924. This was attributed to several reasons that included inadequate financing. To save the Americans from this effect, the government initiated a program where individuals could access funding from the banking institutions. This was enhanced through the creation of Federal Housing Administration (FHA) to provide guarantees to financial institutions where a borrower is in default in payment. This government move encourages lenders to create mortgage loan due to the surety of the safety of the funds they received from the government. The financial institutions were sure to receive protection from the federal government. Initially, there existed a short term mortgage loan where borrowers would access loans for a period of up to five years and engage to pay the principal amount plus interest at the agreed terms. If the home owners were unable to roll over the plan, the loan was foreclosed. The long-term mortgage plan was invented by the government as a result of skyrocketing foreclosures. However, financial institutions were hesitant to advance loans since this meant committing their capital into mortgage plan that is long term. As a result, the government created Federal National Mortgage Association (Schwemle & Tong 2005). This was meant to ensure there was liquidity in the mortgage market. The association would purchase mortgage loans available in financial institutions, freeing up capital so that these institutions could advance new loans.

The United States experienced periods of high interest rates and inflation. The federal mortgage associations were in a position to buy mortgages at adjustable rates with the objective of solving the American Economic Crisis. These associations were able to introduce a product mix that adjusted the rates of borrowing and the cost involved. Financial institutions were in a position to offer affordable loans at low interest rates given the input by the government. As years moved by, innovative products were introduced to allow a greater number of individuals to access mortgages. These programs include the buy downs where the buyer’s payment is subsidized by the seller for a given time that is often short. Graduated payment mortgage is another product introduced to make the mortgage loan affordable to the citizens. Under this program, the payment starts at a low rate but eventually increases as time moves on (Horowitz & Walker 2005).

In 2008, banking institutions and other financial institutions that are exposed to mortgages began experiencing a fall in the prices of their stock, and they were not in a position to sell mortgage assets. Mortgage firms started failing due to the recording of poor performance in the market. The largest US mortgage institution was fled to Bank of America following the plummeting of the stock price. This was due to the existence of Adjusted Rate Mortgage lending. The American economy suffered a financial crisis due to the presence of increased mortgage loans and borrowers failing to honor their obligations. The actions of the government that encouraged capital committing to long-term investment contributed to the plummeting of stock prices. The banking institutions did not take greater caution not to engage most of its capital in a long-term investment, and this played a greater role in the liquidation of these firms.

The intervention of the United States government did not have sufficient impact on ensuring that the performance of the financial institutions functioned normally. The restoration of the financial system is yet to be achieved and further actions need to be taken in ensuring a productive financial system. Several measures need to be taken by the government like the purchase of assets from the financial institutions to relieve them from the burden of risk. This will help to cover the balances in the balance sheet of these financial institutions. Besides, it can help to restore public confidence in the financial sector. The loss of public confidence is evident with such countries as India withdrawing from the stock and exchange market of the United States (Global University Network for Innovation 2006). The burden created by the mortgage and the effects on the economy may be likened to the effects education loan may have on the economic performance.

In analyzing the impact of the student loan and student loan debt, it is critical to start from reviewing the capital model. According to the approach of human capital, education is regarded as human capital investment. The cost in relation to this investment includes the school fees, study material expenses, and opportunity cost in the participation in the labor market. The important cost of these is the opportunity cost which reflects benefits foregone as a result of choosing education rather than participating in the labor market. Benefits in regard to the access of higher education include the job security and future earnings alongside achieving greater career opportunities. Investors in human capital who are rational base their decisions on the analysis of cost and benefits involved in undertaking an additional year of schooling. In the situations where market conditions are perfect, the expectations are that the decision arrived at by the rational being is the optimal and, hence, there is no need for the government intervention. However, the market is full of imperfections that deter making a proper and right judgment and thus the outcome is inefficient. Human capital approach makes an assumption that a student can easily access the credit market. The student does not have to depend on the family financial resources and thus is fully capable of financing education. The financial needs of the students are satisfied by the credit market and hence the student can decide how much to invest in his/her college education. However, the reality on the ground is that students have no easier access to the credit market. This is because banks will always require collateral before advancing a loan and human capital may not be accepted as collateral. In case of default, the bank cannot sell the human capital to recover its dues. On the other hand, the financial institutions lack information as to the capability of the student to complete education and to perform. The information asymmetry may result to moral hazard. Students may fail to put effort to complete education and graduate, on the other hand, they may undersupply their labor thus reducing their capability to first track and meet their loan obligation. The other problem that may persist is in regard to the adverse selection. Students with a high rate of default usually apply for the funding while those who may not default always avoid taking loans. Banks are, therefore, forced to charge a high premium across the board since they cannot distinguish between risky and safe borrowers. The safe borrowers are discouraged by this move to acquire loans since they understand that they contribute towards subsidizing the risky borrowers. Risk premium is further driven up by the adverse selection problem resulting to a credit system that is unsustainable. All these effects create problems in financing higher education. In situations where the banks fail to award credit to students, the government is forced to intervene so that it ensures the objective of the student in terms of accessing higher education is achieved (Delesalle 2008). The government may either provide guarantees and subsidies to commercial banks or engage directly in the provision of students loans. Countries with high income disparities and lack of adequate public support in the provision of education often face difficulties in accessing credit which poses negative implications on the enrolment to higher education.

The other reason as to why the government engages in the provision of education is in regard to the externalities that emerge as a result of human capital. The transfer of knowledge by individuals is often undertaken outside the market transactions. The education benefits in this regard always accrue to those incurred any educational investment (Tulip 2007). In this situation, the society benefits a lot as compared to the benefits accrued to the individual who has invested in education. The social returns are higher in this case as compared to the private returns, thus, resulting to underinvestment in education. To achieve investment level that is socially efficient, the government needs to subsidize in education until an optimal level is achieved where the social returns are equivalent to the private returns.

Education is considered a risky investment. There is no assurance of security of education and jobs are not guaranteed. An individual may undergo education, but there is no surety of getting a job. The existence of market imperfection may reduce the net worth of human capital investment. There is no policy that allows students to insure themselves against these contingencies. Those students who are risk averse will not engage in such kind of investment, and hence they are reluctant to engage in education. Government comes in to restore this situation by offering a product that will ensure the students get access to education. The existence of student loan program is one of the government policies to induce people to acquire knowledge through education. Several other countries have also set such programs where students in higher institutions of learning are provided with loans (Kesterman 2006). Given the market imperfection, government interventions in the education system are deemed necessary. Loan programs developed by the government have several impacts on the performance of the economy and an individual`s life cycle.

Market Structure for Students’ Loans

The market structure has the presence of many institutions and products that contributes to its complexity. The market constitutes of both private and federal students loans. Federal loans for students are found within the Higher Education Act under title IV while private loans are those advanced by the financial institutions. The federal loan program accounts for the highest percentage of the loans advanced to a student. The federal loan program is widely used in the funding of higher education. This program accounts for approximately 75% of projected financial aid in US in 2013. Out of the total number of students enrolled in higher education program many received the federal loan in 2009 – 2010 (Beckendorf 2007). Students loan form part of an extensive program in the United States that aids students in financing their education. Federal grants are made accessible to students who hail from poor backgrounds and are yet to have a degree. A student is awarded $5,550 per year which is the maximum amount given. Other opportunities exist for the needy students who wish to supplement what they receive from the federal loans. Several reforms have been reported in the students’ federal loan program. This has been necessitated by the recession effects and changes in the role played by the federal government.

 Financial market turmoil that came into being since late 2007 created a significant effect on the loan market for student finances. Private lenders were faced with difficulties of raising amounts for students that had been guaranteed loans by the federal program. The tightening of the credit markets forced the investors to demand more in terms of return. These conditions forced the private lenders out of the market. In response to these effects, the federal government abandoned the program of financing the students through the private lenders (Diffeliciantonio 2008). The government introduced a program where the students are funded directly without making use of the private lenders. Several loan products exist both for the parents of undergraduate students and the students themselves. The loans require the borrowers not to have a credit history that is adverse and the repayment procedure should be followed to the latter. Terms of borrowing and pricing are made similar for all borrowers.

The standard repayment period is ten years for federal loans with fixed amounts. There are other repayment plans that exist like the income based but are not widely used due to the preference of the ten year program. Certain issues related to the school may induce cancellation of students’ federal loans. Cases like closure of a learning institution before the borrower graduates may result to cancellation of this loan. Otherwise, the program is expected to run normally and to serve the benefits of the students and achievement of their objectives with the aim of achieving educational goals (Groen 2011).

Other loan products are available in the private sector where students can get a private student loan. These loans serve to bridge the finance gap created by the deficit of the federal government to sufficiently cover the funding of education. These loans are geared towards a profit venture, and the objective of the private institutions is to generate high profits. These loans by the private institutions are neither guaranteed nor subsidized and obtained outside the financial aid office in universities. Guarantors to this type of loan are often sought since the student does not have sufficient credit history to rely on while issuing these loans. Due to the aspects of insufficient credit history, interest rates can significantly vary between different borrowers. Lenders of this type of loan make considerations in regard to the ability to pay unlike in the case of federal student loan. The interest rates for private loans vary according to the market situation unlike in the case with federal loans where the interest rate may be fixed. Private loans are, therefore, associated with higher prices (Hardy & Katsinas 2008).

The student loan debt that is mounting in the United States creates a substantial financial burden among consumers and specifically the young adults. High debt payment restricts discretionary power of purchase, thus reducing credit access of other forms. This is an implication that students’ loan may have adverse effects on students` future lives due to the burden associated with repayment. The repayment burden results to default and delinquency. This is problematic to the borrower`s life as the cycle of life is adversely affected. There has been a dramatic increase in students’ loan debt within last few years. The first quarter of 2012 recorded a debt amounting to $904 billion as compared to $364 billion in the same quarter of 2005. This figure amounts to approximately 13.9% annual growth rate (Williams 2011). The increasing debt amount is being driven by the increasing number of borrowers. There has also been an increase in the average debt in regard to the loans advanced to the students. The increasing individual burden highly affects the performance of the economy.

During the first quarter of 2012, the median borrower owed $13,662 as part of student loan debt. Across the wide range of consumers having the student debt, there is observed average debt of $24,218. There is varied loan debt by student across various states. Several factors may be attributed to the varying difference in the level of student loan debt across the country. These factors may be demographic or social economic among others. The varying difference contributes significantly to the difference in the level of economic growth among varied states within America. The students` loan debts can be distributed over a long period of time given that borrowers have a span of 10 to 25 years to repay the loan in the case of the federal loan. This period is long compared to the periods offered by other types of loans. The burden can be prolonged through several ways that include deferment and delinquency among other factors. The cost of education is increasing, yielding varied results among the various players in the financial market. The increasing cost of education renders increased students debt. There has been a notable decline in the assistance offered by the state to higher education students. This induces the universities to increase the fee payment, thus, contributing to increased burden among the students. Encouraging institutions of higher learning to increase prices has led to increased burden among students. This forces the students to seek loans from private providers in order to effectively acquire the required education. The average student total loan debt is significantly more as compared to the debt held by consumers who do not hold the student loan (Trent, Lee & Owen 2006).

Heavy debt burdens have significant implications on borrowers other than having to meet large repayment amounts. Repayment of the large amounts to a greater extent curtails spending of other forms. This also minimizes access to other types of credits by individuals who still owe amount in terms of student loan debts. Since credit bureaus do not engage in the collection of income information regarding consumers, debt burden is not a sole factor in determining credit worthiness. Delinquency rates imposed on student loans are not higher than delinquency rates imposed on other types of credit (Smith & Fleming 1983). This, however, excludes the mortgage that has suffered skyrocketing delinquency rates over the past five years. The observed increasing delinquency rates have been fueled by the economic conditions that are coupled with recession and recovery which are moderate. All these have dire effects on fresh graduates from colleges who are extremely hit by the situation. The delinquency rates on student loans are also observed to be high even in situations where the economy is functioning normally.

The increasing unemployment rate increases the burden suffered by students. This is because it reduces the income of these students, hence, the amount available to repay the loan. Among the loan defaulters, there are large proportions of those who are unemployed. A study undertaken in California indicated that a rate of 32% among the borrowers fall within the bracket of those who had applied for unemployment compensation. This is a greater percentage compared to 9.7% of those who had not. It is likely that those who remain unemployed and do not default may have probably applied for deferment. The rate of unemployment moved rapidly during the period of recession. Most of the unemployed population falls significantly within the age bracket of young people and who have a significant proportion of student loan debt. In 2010, an unemployment rate of 17.1% among the young people aged 20 - 24 years was observed. The rate within the whole state was 9.9%, implying that the unemployment rate among the youth is far beyond the average. Although the rate is declining, the gap between these two groups still remains. Current research indicates that the unemployment rate of 13.7% exists among the age group of 20 - 24 years compared to an average of 8.3% in the whole state. This is according to a research a research conducted in July 2012 (Stiglitz 2010).

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