No more myths about tuition: American student loans

In every debate about the financing of higher education in the Czech Republic, an American scarecrow appears: as in America, students could not afford education because they had no money, schools would be expensive and inaccessible. However, few are able to tell you how it really works with the US student loan system. Is it really a market problem or just a consequence of government intervention?

Whenever in Europe - including the Czech Republic - someone raises the question of tuition and paid higher education, the scarecrow of American student loans comes out.

Fear of tuition fees prevails, fear of students' extreme indebtedness prevails. This fear is unjustified: the system as it is set up in the USA, is not private financed system and state interventions are the root of extreme indebtedness of students.

How do US student loans work?

The system is relatively clear: the prospective student borrows money for tuition, college, and other college expenses, and promises to return the money when he or she graduates. The fact that some pay, for example, "trips around the world" by those money, will now be left out.

Student loans must be repaid - there are a few cases where all or part of the loan can be forgiven, but these cases are rare. In general, it is possible to request partial or full remission if:

  • you work like full time teacher five (academic) years at some schools - then you can apply for forgiveness of $ 17 500,
  • you work in public or non-profit sector (after 120 monthly installments from the salary from the public or non-profit sector),
  • you will become permanently disabled,
  • you use the federal program for protection of debtors, if you prove that your school has misled you or acted against the law.

These cases are rare - 0,3% the volume of student loans is waived, which concerns 0,7% of borrowers. At the same time, 6,7% of debtors apply for forgiveness and the number of rejected applications grows every year - four times in the last 2 years; taking over 70% the volume of forgiven loans goes to teachers. And yet there is still a problem with quantity of teachers in the United States.

The number of approved applications for waiver in absolute numbers is more or less the same. Let's add that Student loans bear interest on a daily basis and interest is repaid first. It may happen that during the repayment the student will sometimes repay less than the extent to which the principal has benefited from the last installment and after the repayment the total debt will be higher.

What types of student loans exist?

We're starting to get to where the myth of expensive American schools is rising from: There are two basic types of student loans:

  1. Private - provided by banks, credit companies and the like. Conditions, repayment period, form of interest depends on the specific company and the specific loan, these are usually more expensive loans - with higher interest rates.
    Private loans makes up 8% of the total volume of borrowed money. That's $ 135 billion this year, with 88,5% used to fund a bachelor's degree. The interest rate on private loans ranges from 1,09% to 12,99%; whereas cheaper are generally loans where the interest rate is variable (ie it may change over time depending on your situation). The greater the fixation, the higher the interest rate (as with a mortgage).
  2. Federal, provided by the government. Federal programs currently accounts for 92% of student loans. The interest rate ranges from 2,75% to 5,3% and is always fixed throughout the repayment period.

Overall, in the US has some form of student loan this year 44,7 million citizens, whereas 42,3 million citizens has a loan through federal program - so they owes to their government.

When someone starts telling you that the problem of US student loans indicates the inability of the market to provide affordable education, remind them that The problem of American student loans is the government problem, the problem of debt to the government. It is not a problem of the private sector and private loans!

If you're reading a heartbreaking story about how a poor US college graduate can't afford health insurance or a mortgage because of his or her student debt, it's most likely because of his debt to their own government, not because of private loans!

Types of Federal Loans

There are 3 types of federal student loans - what a student can get (and in what amount) depends on their and their's family financial situation (the so-called FAFSA form):

  1. Direct subsidized loans: loan for students who, according to their FAFSA, are entitled to a subsidized loan. Subsidized then means that the government pays interest for the student (in essence, interest is forgiven) during the study period. After graduating from school or if the number of hours in school falls below a certain number, a six-month grace period begins to count, during which interest begins to rise and after which the student must start repaying his loan.
  2. Direct non-subsidized loans: a federal loan for which you do not have to prove your financial situation, however interest starts to be calculated from the moment the tuition is paid on by the borrowed money.
  3. Direct "PLUS" loans: These are loans for parents who can take out this type of loan to provide for their children, or for students in post-graduate programs. The FAFSA form must be provided for these loans.

Repayment methods are:

  • either according to a fixed or gradually increasing set repayment calendar (federal loans 5-10 years, private loans in various ways). If you owe more than $ 30 000, you can extend your repayment schedule for up to 25 years;
  • or automatic deductions from wages, when - according to the method of calculating income - it is about 10 - 20% of the debtor's income with the aim of repaying the debt in 10 - 25 years (there are 3 ways to calculate the income and the % to be repaid).

If you can't afford to repay (let's not forget that between installments, interest is calculated daily ), you can:

  • ask for suspension of installments (but interest is calculated, every day),
  • ask for deferred payments (if you reach it, you do not have to pay temporarily and you may not be charged interest) - they are often entitled to a deferral soldiers serving in the army during the war or in peacekeepers or unemployed,
  • declare bankruptcy, when your debt can be resolved in court, confiscate your property, you may lose the right to further financial assistance, you will not get a mortgage…,
  • on average 15% of student loans are sometimes in arrears, with 11% of debtors in arrears during the first year after graduation, 25% during the first five years. Students studying the lowest forms of higher education are most often delayed, in the case of fields - the most risky are arts and humanities.

Federal loans cause tuition inflation

This is an exemplary situation where state intervention - "cheap money" - inflates the price of assets. In the system of private financing, education has all the conditions for it to become cheaper in the long run.

Let's summarize:

  • federal loans are responsible for more than 90% of the volume of the student loans,
  • private programs then for less than 10%,
  • The vast majority of student debt is used for bachelor study, ie on entrance level of university education,
  • highest interest rate of the federal loans is roughly half than for private loans,
  • the average recipient of a student loan owes $ 37 584, with the average installment now working $ 393,
  • roughly 67% student debt during 20 years is interest.

This is an exemplary situation where state intervention - "cheap money" - inflates the price of assets. Education is an asset. Government programs artificially hold low interest rate to secure them, causing the wrong capital allocation over time. Risk areas (from the point of view of future repayment) are becoming artificially cheaper (arts and humanities) and are being studied by much more students. They then have a problem finding a job and a repay their debt (from 90% + against the government).

It's about direct tuition inflation. Increased demand for some field of study would normally be offset by an increase in the interest rate on private lending. Long-term fixation and a lower interest rate make this impossible. Thus, students always have "new money" available to pay tuition fees: no matter how much the university increases the price of tuition fees, students always can pay them and the price mechanism thus - due to the capacity of the education system - pushes the price of tuition up.

If a school has 100 places that more than 100 students apply for each year - though the school is already built, the chairs are already bought and most of the school costs are drowned / written off or fixed, the school has no reason to discount (which would be a natural development in such a field due to competition!), but vice versa they are rising prices to regulate interest.

Government-subsidized programs (all are subsidized by lower interest rates and fixations) thus force students to ask for larger and larger principal in debts, from which more and more expensive interest is calculated in absolute numbers. By wanting to provide "something" to "everyone" in the world scarcity is not eliminated, and somewhere the lack of resources must manifest itself. Here it is in the growth of tuition.

Schools in the environment of moral hazard

In a free market without a "federal cheap financing alternative", private creditors (banks, for example) would not lend for tuition at a school whose students have great difficulty repaying their loans. Such a school would have to improve or leave the market.

And what will happen to a school that will have a lot of graduates who will have trouble repaying?

Nothing.

It will not reduce the number of those who want to study at school, because federal programs will always provide funding. The amount of loans to be written off will not increase for the school, because the school itself does not hold the loans. The school will not go bankrupt because of this, the fields will not become unprofitable because of this.

In addition to inflating asset prices with cheap money, we see an exemplary moral hazard here. In a free market without a "federal cheap financing alternative", private creditors (banks, for example) would not lend for tuition at a school whose students have great difficulty repaying loans.

Such a school would have to either significantly reduce the prices or improve the quality of its graduates, or leave the market and make a place for better institutions. However, this mechanism does not work due to federal programs.  

The American education system is a problem of state intervention

The American problem of student loans proves the need for market education: whether we have education financed directly from taxes (Czech example) or through subsidized loans, we have a problem with financing and accessibility.

Education is capital and education is a business with a high rate of fixed / sunk costs, where over time it is becoming cheaper to provide the service and naturally there should be a reduction in real prices.

But we do not see this in practice, because the state inflates the price of tuition with subsidized loans and relieves the school of responsibility for the results of its own business. The whole then is then paid by the students:

  • according to Ramsey Research, 63% of the debtor live in permanent fear of their own ability to repay
  • 44% of borrowers cannot afford to buy their own housing due to student loans

It is the massive failure of the state that has created this socio-economic problem. This is not a market problem: for 92% of the debt, the creditor is the state!

A song at the end

0 comments

  1. I do not think that subsidies are in themselves a sufficient justification. Undoubtedly, this has an effect; with the offer unchanged, the equilibrium price after the subsidy should be theoretically should be the same as the equilibrium price on the hypothetical market without subsidies. Yes, it is a simplification, because education is not exactly homogeneous (ie we do not have a single product that is "university education", but differs in the type of education and quality) and irrationality can play a role here. What's more, it gets complicated when only a fraction of people receive the subsidy - however, as far as the majority is concerned, it probably won't have that much impact.

    1. @ v6ak in my opinion it is a key factor in the long run. The system is basically the same as in the Czech Republic: it is financed by the state, only the amount of the subsidy is not determined by state organizations (in our country and the PSPČR through the parliament), but by the subsidy recipients themselves (universities). As much as they say, they get as much because the student has such coverage through a federal loan. A higher price does not limit the demand - the school will raise the price -> the demand is still big -> the school will raise the price -> the demand is still sufficient… and so on.
      At the same time, there is a problem with interest: the loan is of an investment nature - the "bank" estimates how much the student is able to graduate from the school and what bribery he is able to obtain in the field. The government captures interest here and the private sector is pushed out, which artificially lowers interest = it artificially pretends that it is a "cheap" investment, as if it were not risky. But she is often risky, but we don't know that, because riskiness is not reflected in the price. If you were considering studying in two fields, you would get an interest rate of 6% on one and 15% on the other, you immediately know what is probably more interesting for you in the long run - the bank will calculate it for you 🙂
      Today, with a federal loan, but you get a maximum of 5,7% for each - the riskiness of the branches "looks" the same, while at that moment the branch that would have the interest of 15% in the market environment is advantageous (it is artificially discounted at almost 1 / 3!), So logically more students will study it, who will find it harder to find a job (the field is even riskier, further interest rates would rise in the coming years - but they can't because the federal government lends artificially cheaply, there is no market valuation). They then pay less off (see humanities and arts), while in other fields there is a shortage - inefficiency arises. One day it will break and the debt will have to be written off. This will either be a huge burden on the federal budget or it will dissolve in inflation.

      After all, it is an example of ABCT 🙂

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