As the price of college tuition continues to climb, concerns about student loans, and thus student debt, have increased. Roughly 71% of newly graduated students in the US come out of school with some form of debt. 65% of these graduates admit to not having a clear understanding of how their student loans work. Student debt now totals over $1.2 trillion dollars. How do these loans work? And how do these massive figures of debt affect the economy.
Student loans are comprised of two main categories: federal and private. Typically, federal loans have low, fixed interest rates. However, they also have a maximum amount that can be lent. Many times this maximum amount isn’t enough to cover all the expenses of attending school. The most common form of federal loans are known as stafford loans; these low-interest rate loans are available to almost all students.
On the other hand, private loans have variable interest rates but do not have a limit on the amount borrowed. The variable interest rates are based either on the rate banks charge each other for loans, otherwise known as L.I.B.O.R., or on the creditworthiness of the borrower, otherwise known as the Prime Rate.
Despite loans being relatively easy to obtain, it has become very difficult to default on them as restrictions and regulations have increased over the years. Though the interest rates can theoretically begin compounding immediately upon signing, both private and federal loans typically offer forbearances which essentially are grace periods when no interest is compounded onto the outstanding loan. Without such grace periods, a student who signs a loan for $100,000 with a 9% fixed interest rate can face an outstanding balance of $136,000 upon graduation. Because of this dilemma, the government subsidizes some of these loans and effectively pays off the interest while the student is attending school, so that upon graduation, they only face their original loan of $100,000.
$100,000 is a lot of money. As a result, paying down this debt reduces the amount of money people can spend on other goods and services. Economists have noted changes in the behaviors of the millennial generation which has become bogged down by increasing student debts. For example, after graduation, roughly 27% of college students move back in with their parents to save money. People also are holding off on key decisions such as buying cars or applying for house mortgages - even marriage - because of their student debts.
Student debt serves as a setback to many and limits borrowers from interacting in the consumer economy. As student debt continues to climb, the implications for the economy will become more severe, and Washington will face growing pressure to address the problem.