BRB Bottomline: Despite ostensible claims that student loan debt helps lower-income students, women, and minorities advance themselves and their families through education, the current system subjects those very students to cycles of financial insecurity and propagated socioeconomic discrimination. In this article, we identify three pernicious but implicit effects of student loans: lower academic performance, fewer early-career opportunities, and longer time until financial independence.
The importance of getting a college education is rising just as student loan debt in the U.S. has skyrocketed from $600 billion in 2006 to past $1.5 trillion today. While the average cost of a four-year degree has doubled to nearly $105,000 over the last two decades, real median wages have only risen a modest $5,000, according to an independent report by Forbes. These trends are perhaps backed by good intentions. Like well-intentioned policies that encouraged homeownership as a basic human right in the decade before the Great Financial Crisis, access to higher education has become increasingly democratized: women make up 56% of students enrolled in universities, and minorities have made significant pushes in enrollment.
Higher education has been lauded as the great equalizer of society, allowing those from lower socioeconomic backgrounds to climb the economic ladder. Issuing federal student loans was seen as the primary mode through which the financially needy could tap into and invest in their own human capital.
However, debt is a double-edged sword. For some, student loans are the rungs that help them and their families climb out of poverty; for many, those student loans are shackles that merely exacerbate the socioeconomic divides between privileged demographics and historically-prejudiced groups.
The Failure of Financial Aid
Financial aid comes in two flavors: gift and self-help. Gift aid includes grants and scholarships—funds that help you get an education without having you repay in the future. Self-help aid includes work-study and student loans—funds that either require you to work for the money or eventually pay back the aid with interest.
If people who need aid get aid, and people who don’t need aid don’t get aid, student loans shouldn’t be a problem, and everyone should be able to graduate without debt.
The kink in the system is that there aren’t enough private donations and federal funds to give every need-based student the gift aid they require. So, after filling out the FAFSA (Free Application for Federal Student Aid), even if a student’s estimated parent contribution is zero, they will only receive enough gift aid to cover up to their self-help amount, which leaves around $10,000 on the tab, depending on the institution. The student will have to take the rest out in student loans, work-study, or other means, i.e. money that is worked for or must be paid back.
The reality about student loans is shocking. In public institutions, for students who received the Pell Grant, reserved for students with exceptional need (family income less than $50,000), 84% graduated with debt compared to only 46% of students who didn’t receive the Pell Grant.
While the amount of federal aid has increased, the cost of higher education is growing faster than coffers for financial aid, which has fueled the recent surge in student loans.
Why Are Minorities and Women Mired in Student Loans?
Minorities and low-income students are more likely to take out debt and take out larger amounts of debt, according to a report by Demos. Moreover, women hold more than $900 billion in student loans, nearly two-thirds of the total, despite only making up 56% of college students. The women and minority experience is compounded by pay gaps after college, on top a lack of intergenerational wealth before college, which perpetuates cycles of socioeconomic stratification and forces these demographics to carry the burden of student loans much longer than other educated professionals.
On the topic of intergenerational wealth, students with parents who are well-to-do or who have grandparents and relatives who stashed money away in a 529 College Savings Plan are able to give their student a college experience without burdensome student loans. Not only are students who come from middle-upper-income families better able to concentrate on their studies when they get into college but also their college choices at the outset are wider than students without these opportunities. Familial connections, access to counselors and test prep, and strong support systems all contribute to the failure of a for-profit college system. The upper class is able to finance their education debt-free, the middle class can leverage financial aid as supplementary cash flow, and the poor struggle with student debt.
The pay gap between women and minorities and their male counterparts is well-documented.
A study conducted by the National Center for Education Statistics (NCES) showed the median annual earnings of 25- to 34-year-olds with a bachelor’s degree and found that—when isolated by demographic and gender—women, blacks, and hispanics earn less than their males and white counterparts. The pay gap decreases for women aged 25-34, compared to the pay gap for all women above 16, which highlights the power of education to create economic opportunity and equalize social disparities; however, the pay gap still persists at 89% parity (women earn $0.89 on the dollar). The pay gap makes paying down loans even more difficult, which impedes the ability of these groups to compound wealth and provide for themselves and their families.
If not federal funding, private scholarships are another avenue to finance one’s education. Many argue, and at times it seems true, that the amount of private scholarships overwhelmingly favors women and minorities.
However, according to Mike Kantrowitz, a student loan expert, Caucasian students receive more than 76% of institutional merit-based scholarships, while representing only 62% of the student population and are 40% more likely to win a private scholarship than their minority counterparts. To those who argue that race plays in favor of minorities, less than 5% of scholarship programs and 10% of all individual scholarships consider race a prerequisite for applying.
The Effects of Student Loan Debt
Now that we’ve talked about some of the overarching systems of student loan debt that disproportionately affect women and minorities, we turn to the effects of this debt and how they exacerbate the struggles of historically disadvantaged groups.
Lower Academic Performance & Drop-Outs
As minorities increasingly turn towards student loans to finance the degrees that firms demand, they must disproportionately deal with the burdens of borrowing student loans. In College Financing Choices and Academic Performance (2018), Christiana Stoddard and Carly Urban, researchers in the Economics department at Montana State, found that students who take out loans have lower grade point averages (GPAs), take fewer credits per semester, and have lower retention rates than students who do not.
Students who are forced to work or who take out loans tend to have worse academic performance, which translates to transcripts that handicap their competitiveness for early career opportunities out of school. A hiring manager isn’t going to risk their job to go out on a limb to hire a student who has a lower GPA than another equally-qualified candidate.
Additionally, student borrowers have a nearly 30% change of dropping out, up from 20% in 2001. The average dropout will carry with them around $15,000 in student loans. Moreover, college dropouts have fewer opportunities available to them to pay back that debt because good-paying jobs today require a college degree.
Fewer Early-Career Opportunities
While still in school, students who face academic pressure are less likely to apply to internships or partake in extra-curricular activities since they typically need to work and earn extra income. Part of the financial aid package often offered to students includes “work-study,” essentially on-campus jobs to makes securing a job easier.
According to a study conducted at Georgetown, 65% of higher-income students who work less than 15 hours a week earn grades of B or higher, while 60% of low-income students who work more than 15 hours a week earn grades of C or failing. The additional stress of work, especially when it’s a necessity (as represented by the Georgetown Study), show the detrimental impact of financial insecurity on academic and personal success.
Moreover, students with loans have less flexibility to pursue internships or take prestigious opportunities because they have to make money during school or summer to pay the interest. Then, once they graduate, women and minorities face additional pressures to secure a high-paying job out of college because they have to start paying back principal. Without monetary security or family support, they aggregate towards jobs with marginally higher pay but less climbing potential, which further limits their early career opportunities.
Longer Time Until Financial Independence
Once a student exhausts the grace period for which they don’t have to pay principal—six months after graduating—they enter a repayment plan with their loan servicer to pay, monthly, according to the maturity of their loan. The standard repayment plan typically has minimum monthly payments of around $50. Of course, there are longer-term plans: graduated repayment, extended repayment, pay-as-you-earn repayment, etc., but these plans incur higher costs over the course of repayment.
For new graduates or drop-outs already struggling to find jobs and make rent, disposable income is few and far between, which makes it difficult to pay down the loan or even meet minimum payments. If they ever miss a payment or default on the loan, their credit is negatively impacted, further damaging their financial independence and future earning power.
Reputable firms want to select the highest-qualified candidates out of college, but, because these firms are well-known, they enjoy a monopsony over a large applicant pool, which drives starting-salaries below those of less-reputable firms. Despite women and minorities making up more than three-quarters of college graduates today, many talented candidates are disincentivized to apply for reputable firms, instead seeking out higher-starting salary positions to pay back their loans. To combat these strong disincentives to apply, firms can create a student loan refinancing program that either reduces the interest rate, extends the lending period, or locks in long-term employment contracts that reduce employee turnover and build social capital.
This program is tax-deductible for both parties and doesn’t depend on the credit history of the employee because the underwriting risk lies in the employee’s continued employment with the firm. This solution would incentivize students who may be highly qualified, but carry significant debt, to apply. Business Review at Berkeley is in the process of producing a comprehensive solution to the student loan problem. We’ll link the report to this article when it’s ready.
A more subtle, but pervasive, solution is to challenge our implicit biases and perceptions. We must challenge employers and ourselves to upend the negative, unspoken beliefs we carry towards minorities, women, or low-income individuals. While the pay gap may be shrinking, its mere existence exemplifies our need for progress.
Job applicants with lower GPAs or fewer extracurriculars should be given an opportunity to explain their extenuating circumstances. Their struggles—overcoming prejudice and discrimination, balancing work hours with school, etc.—often preclude them to the skills employers most desire in new hires.
Take Home Points
Well-intentioned programs providing student loans to women and minorities may have unintentional consequences. While access to student loans gives young people from lower-income, disadvantaged groups an opportunity to better themselves and their families, they can also have pernicious effects that perpetuate socioeconomic stratification. When students have to deal with the burden of student loans, they get lower grades, fewer early career opportunities, and take longer to reach financial independence. The solution that we propose solves the student loan problem for the student and helps employers attract the highest talent available to them.