Navigating Student Loans: Are They Worse Than Other Forms of Debt?

Achieving higher education is generally seen as a beneficial investment, both for individuals and the economy. Financing this education often requires taking out student loans, which can enable students to enroll in post-secondary education and reap the rewards of a college degree. However, the growing amount of student debt in the United States has sparked debate about its potential negative consequences and whether student loans are "worse" than other types of debt.

The Rising Tide of Student Debt

Student debt in the United States reached approximately $1.60 trillion. This substantial figure reflects a growth of nearly 40 percent since 2014, signaling an increasing reliance on loans to finance higher education. This rise has prompted policymakers to propose various solutions, including restructuring repayment plans and even considering student debt cancellation.

The Enduring Value of Higher Education

Despite the increasing costs of tuition, the rate of return on a college education remains high, ranging from 14 to 36 percent depending on demographics. This return substantially surpasses benchmarks for other secure investments like long-term stocks or bonds. Individuals with college and advanced degrees typically experience this return through higher wages and are generally less likely to face unemployment or underemployment.

Beyond individual benefits, higher education also yields important societal effects. The presence of more educated workers can lead to a “knowledge spillover,” increasing the productivity of others in the workforce.

The Downsides of Student Debt

While higher education offers numerous benefits, the accumulation of student debt can have negative implications.

Impact on Homeownership and Wealth

Homeownership rates have declined since the Great Recession, particularly among young Americans in their 20s and 30s. This demographic experienced nearly twice the decline in homeownership rates compared to the general population between 2005 and 2014. Student debt may contribute to this trend by jeopardizing household finances and leaving borrowers worse off financially than previous generations.

A recent study by the Federal Reserve revealed that households with student debt had a net worth that was, on average, over three times lower than the average for the whole population. In 2022, 40.2 percent of households headed by someone aged 25-39 owed student debt, a significant increase from 19.0 percent in 1994. This prevalence and amount of student debt among young adults today may be associated with why they hold less wealth than previous generations did at the same age. Lower net worth can also make it harder for households to weather economic downturns.

Hindrance to Small Business Formation and Family Formation

Growing student debt levels can also hamper small business formation, especially for firms that rely on personal capital injections for growth. Additionally, monthly student loan repayments have been linked to lower and delayed family formation for adults who attend some college or graduate from college.

Federal vs. Private Student Loans

When evaluating student loans, it's crucial to understand the distinction between federal and private loans. These two categories differ significantly in terms of repayment and consolidation options.

Federal Loans: These loans are offered by the government and typically come with more flexible repayment options, including income-driven repayment plans and potential loan forgiveness programs like Teacher Loan Forgiveness and Public Service Loan Forgiveness. They also offer benefits like forbearance and deferment during periods of financial hardship. Federal loans do not require a credit check or cosigner for direct subsidized and unsubsidized loans.

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Private Loans: These loans are offered by private lenders, such as banks and credit unions. They often require a strong credit score and may necessitate a cosigner if the borrower's credit or income is insufficient. While private loans may offer lower interest rates to well-qualified borrowers, they generally lack the flexible repayment options and forgiveness programs associated with federal loans.

If you don’t know which of your loans are federal and which are private, there are a few options for you to find out. First, you can review each of your current monthly loan statements and look for the words ‘Federal Direct Unsubsidized, Federal Direct Subsidized, Federal Perkins or Federal Direct PLUS Loans’ on the payment section of your monthly statement or online account. Alternatively, you can log into your Federal Aid account or at the National Student Loan Database and view your federal loans there. Once you determine which of your loans are federal, you can assume that any remaining loans (if any!) are private or alternative loans.

Factors to Consider When Choosing a Student Loan

Deciding on the best type of educational loan involves considering various factors beyond just the interest rate. These include:

Repayment Options: Evaluate the available repayment plans, such as standard, graduated, and income-driven repayment.
Deferment and In-School Repayment Requirements: Understand the terms for deferring payments during periods of financial hardship or while enrolled in school.
Cosigners: Determine if a cosigner is required and the implications of having one.
Tax Benefits: Explore potential tax deductions for student loan interest payments.
Consolidation or Refinancing Options: Investigate the possibility of consolidating or refinancing loans to simplify repayment or potentially lower the interest rate.

Strategies for Responsible Borrowing

To minimize the potential negative impacts of student debt, consider the following strategies:

Be an Informed Consumer: Research different loan options and understand the terms and conditions before borrowing.
Borrow Only What Is Needed: Avoid borrowing more than is absolutely necessary to cover educational expenses. If a family has the ability to cover the cost of books, supplies, and other living expenses out of pocket, they should borrow just enough to cover what their remaining yearly balance will be after financial aid.
Explore All Financial Aid Options: Exhaust all grant, scholarship, and work-study opportunities before resorting to loans.
Consider Future Earnings: Factor in anticipated future earnings when determining how much to borrow.
Prioritize Federal Loans: Opt for federal loans whenever possible due to their flexible repayment options and potential forgiveness programs.
Understand the Implications of Private Loans: If considering private loans, carefully evaluate the interest rate, repayment terms, and potential risks.
Create a Budget and Stick to It: Develop a budget to manage finances and ensure timely loan repayments.

Student Loans and Graduate Programs

If you have student loans already from a previous degree, there are two main categories of student loans: federal loans and private or alternative loans. These two categories are very different from one another when it comes to repayment and consolidation options, so it’s important to take inventory of what type of loans you have already to ensure your graduate educational debt ‘plays nicely’ with your existing loans when it comes to repayment. There is nothing worse than needing to write eight or ten or more checks a month for small individual loans that cannot be consolidated (aka merged) together.

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When it comes to monthly payments, consolidation, deferral, and payment plans, federal loans can only be combined with federal loans, and private loans can rarely be combined with anything. In fact, in most cases, if you have three different private loans, even if they are with the same servicer, you may still be required to make three separate payments. This same tenant is true for graduate student loans as well. Graduate federal student loans can be easily and automatically combined with any other federal student loans that you have, which means a lower monthly payment in the long run for you. So, if you have federal student loans from previous education, and you are seeking the most affordable and flexible repayment options, federal graduate student loans are a no-brainer. Furthermore, you also retain the advantages of forbearance, deferment, Teacher Loan Forgiveness and Public Service Loan Forgiveness that are only available for federal loan holders.

If you do not have federal loans from previous degrees, or if you are looking for the best interest rate and are comfortable with potentially a higher monthly payment for less interest paid during the life of the loan, then a private loan might be something to consider. Private loans do require a strong credit score and consistent income, but they give you the option of a strong cosigner if your credit or income is less than what you want it to be. This contrasts with federal graduate loans which start at around 6.6% for the 2018/2019 award year. While this interest rate difference might sound massive, it’s only an average difference of $285 a year in interest on a $10,000 loan. But, for the consumer who is looking for the best rate and the lowest cost over time, it may be a good option with one caveat. Often the lowest interest rate private loans are variable and are not fixed rates.

In summary, if you have existing federal loans, it’s almost always the best decision to take a federal graduate loan for your graduate studies. This ensures you the most benefits when it comes to monthly payments and the potential for loan forgiveness down the road. If you do not have any federal loans from previous education, and you have a strong credit and financial status, a private loan may be worth the consideration.

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