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Investors and Advisers Grapple with Challenges of Student Debt
President Obama’s proposal for free community college highlights the consequences of rising student debt.
In his State of the Union address on January 20, President Barack Obama announced more details of his plan to make two-year community college free for all qualified students. Under the proposal, the federal government would cover 75 percent of the cost of community college with an additional 25 percent borne by the states. If all 50 states participated, the total number of students benefiting could exceed 9 million annually.
From a big-picture standpoint, the advantages of universal college education are clear. Economists agree that increasing the average education level of a nations labor force leads to higher productivity. At the household level, the effect of higher education is even more pronounced. U.S. Department of Labor data clearly indicate that in an increasingly competitive job market, a college degree is necessary to enter the middle class.
With college increasingly critical to social mobility, the big question facing U.S. households is how to finance the pursuit of a degree. For many students, the only solution has been to take out education loans. This has had a dramatic impact on the economy. The latest data from the Federal Reserve place total U.S. consumer credit at $3.3 trillion. At least $1.2 trillion of that is estimated to be student debt, with roughly $1 trillion guaranteed by federal agencies. According to the Consumer Financial Protection Bureau, the amount of total college debt outstanding rose by 20 percent between 2011 and 2013.
At the same time that college has become increasing difficult for families to afford without taking out loans, the price tag has risen rapidly. The National Center for Education Statistics estimates that the average cost of attending a four-year college or university has more than doubled on an inflation-adjusted basis since the early 1980s. After two decades in which national wage growth trended downward, tuition inflation has been difficult for even affluent families to keep up with. As a result, the number of students taking on debt has increased as tuition costs have risen significantly. The Institute for College Access and Success estimates that 69 percent of 2013 graduates had outstanding loans.
I will be paying off my student loans until I die, literally, says Julie Jakolat, an entrepreneur in New Yorks upper Hudson Valley. I dont even really think about retirement and savings at this stage. Jakolat shares a story with millions of Americans who are facing middle age still saddled with student debt.
Even for financial advisers working with wealthy families, rising college costs and increasing student loan debt are important factors as they construct financial plans. For many families it can seem overwhelming, says Dennis Mojares, a wealth management adviser with CBG Financial in Madison, New Jersey. Young professional families that start off in debt for education typically utilize company-sponsored retirement plans but save little else as they focus on paying down loans and mortgages.
According to Mojares, rising life expectancy and increasing health care costs, particularly in old age, have forced families that would otherwise have paid for their childrens educations to instead protect their nest eggs and allow the younger generation to leverage their futures. Their children start adulthood with high debt levels and struggle to save for later life. Jakolat was fortunate. Her parents paid for her undergraduate degree at Californias San José State University. A masters degree and doctoral studies at New York University, however, combined with an additional masters from Baruch College, all financed through federally guaranteed loans, left her monthly debt service too high for her to contribute to retirement plans. Of her degrees she says, They havent proven to be a winning investment.
The decision whether to pay down debt aggressively or start investing is often a matter of doing the math on loan costs versus the expected return on investments. Younger generations saddled with debt can get confused about paying off debt versus building up retirement savings, says Will Tuhacek, a senior wealth adviser at San Franciscobased FutureAdvisor. As a society, we teach kids to save and invest, the sooner the better, but paying down debt may actually make more sense for many people.
Tuhacek notes that student debt originating prior to the credit crisis is often at rates much higher than current levels. He points out that the forecasted rates of return on investments cannot be guaranteed, but interest rates on debt can be. By not paying down that debt, youre essentially borrowing money to invest. Thats what we call an investment headwind, which can be very big if youre paying 7 or 8 percent on your debt, he says. Tuhacek cautions that debt-servicing costs, posttax analysis and other factors must be weighed to find the right balance between investing and getting debt free.
A separate concern over rising student debt levels is the for-profit education sector. Privately operated institutions, including trade schools and online colleges, have been criticized for aggressively targeting students eligible for federally guaranteed loans that they may not be able to repay. U.S. Department of Education data show that 44 percent of defaults among student loan borrowers were accounted for by those who owed money to for-profit schools. The average default rate for the segment was 19.1 percent between 2011 and 2013, versus slightly more than 7 percent among graduates of private colleges. For advisers, the for-profit academic sector has been volatile from an investment standpoint. Last year the Department of Education reached agreement with one publicly listed for-profit chain, Santa Ana, Californiabased Corinthian Colleges, to cease operations after it falsified employment, attendance and grade data. The companys shares closed the year down 96 percent.
But it wasnt alone. Pittsburgh-based Education Management Corp. also saw its market capitalization evaporate in 2014 and faced delisting from the Nasdaq. For the rest of the stocks in the sector, the impact of President Obamas community college plan would be catastrophic. If you have students who are debating whether to attend a for-profit school versus a community college, the choice will be clear, says Michael Tarkan, a research analyst with Washington-based Compass Point Research & Trading. According to Tarkan, the key advantage held by for-profit institutions has been aggressive marketing that helped them woo prospective students who might have pursued a community college degree, often at a significantly lower price. Universal free access to community college would undo that advantage overnight.
Tarkan is not worried however. By his estimation, the chance that the presidents plan will receive congressional approval is near zero. Its our view that this will not happen, he says. Youre not going to see the political will for a program that will cost up to $60 billion in the first decade. Tarkan and his colleagues point out that Pell Grants currently address this issue for some of the poorest prospective students, and federal loan-forgiveness programs will alleviate additional pressure on many of those same individuals later in life.