ByRajeev R. Bhaskar , Yadav K. Gopalan
High school students contemplating going to college are confronted with a myriad of questions, including how much it will cost and how they will pay for it. Unfortunately, the cost of education keeps rising and the availability of credit, especially in this current economic environment, keeps dwindling. This article takes a closer look at various aspects of the financial needs of college-bound students, from what makes up the overall cost to what types of student loans are available. We also look at the rising cost of college and the impact of the credit crisis on student loans.
Going to college can be expensive. There’s tuition and fees, but there’s also room and board, books and supplies, transportation, and other miscellaneous expenses.
The cost breakdown for these categories as a percent of the overall cost varies by the type of institution (private or public), in-state or out-of-state, two-year or four-year.
According to the College Board 2007-2008 survey, published tuition and fees constitute 67 percent of the total expenses for students enrolled in a four-year private college. This compares to 60 percent for out-of-state students enrolled in a public college, 36 percent for in-state public students and 17 percent for a public, two-year college.
Room and board, on the other hand, comprised the largest category of expenses for a student attending a public two-year college and for an in-state student attending a public four-year college. The pie chart breaks down the expenses for a typical out-of-state student attending a four-year public school. Tuition and fees comprise the largest share (60 percent), followed by room and board (27 percent), books and supplies (4 percent), transportation (3 percent), and other miscellaneous expenses (6 percent).
Students who attend college choose from a variety of options to pay for the overall costs. According to a 2008 Sallie Mae-Gallup study, parents pick up the largest part, paying 48 percent of the overall cost of college. An average student covers 33 percent of the cost with income, savings and loans. Grants and scholarships contribute 15 percent toward the cost, while the rest is made up by support from friends and relatives.
The study, which involved interviewing hundreds of families with college-aged students during the 2007-2008 academic years, breaks down the 48 percent provided by parents into 32 percent from income and savings and 16 percent from loans. Similarly, the student contribution can be broken down into 10 percent from income and savings and 23 percent from loans. Therefore, the overall amount of borrowing by students and parents is close to 40 percent of the overall college costs, which is significant. The types of borrowing that parents and students typically use include: private and public educational loans, home equity loans, credit cards, retirement accounts and other loans.
Disparities exist, however, in contributions across income levels. Higher-income families—those with income of $100,000 or higher—on average pay more from income and savings, compared to middle- and lower-income families. Middle-income families—those with income between $50,000 and $100,000—rely most heavily on loans, while lower-income families, on average, receive more scholarships and grants.
The Sallie Mae-Gallup study reaffirms the importance of loans and that savings and income alone are not enough to pay down college costs. Although parents and students use many types of loans, we focus here on educational loans. Educational loans are divided into three broad categories: federal student loans (Stafford and Perkins), private education loans and parent loans.
The most common educational loans taken to finance higher education are federal student loans. These loans typically have lower interest rates with no credit check or collateral required. They come in two basic forms: the Stafford loan and the Perkins loan. Stafford loans are the most popular loans among students and are sometimes subsidized by the federal government. Perkins loans, on the other hand, are meant for undergraduate and graduate students in extreme financial need.
In addition to federal loans, private education loans also are available to students. Private lenders usually use students’ credit scores to make the loans, which often supplement federal loan amounts that are not enough to pay for costs. In addition, private educational loans often provide flexibility in repayment.
Parents also take out educational loans for their dependent children in the form of the Parent Loan for Undergraduate Students (PLUS). Loans through this federal program can be used to cover any costs not already met by the student’s financial aid package.
Both the government and financial institutions provide funding for student loans. Financial institutions—banks, credit unions, thrifts and other lenders, including nonprofit organizations—participate in student lending either by providing the funds for federal loans such as Stafford and PLUS through the Federal Family Education Loan (FFEL) program or by directly making private student loans. According to the web site www.finaid.org, there are over 2,000 education lenders nationwide, although most of the volume comes from the top 50 lenders. The top 50 include most of the big banks, as well as several nonprofit organizations. Sallie Mae, once a government entity but now private, is the largest lender.
Figure 1 shows consumer loans—auto loans, student loans and medical and other personal expense loans—as a percentage of total loans at all U.S. banks and U.S. community banks (banks with assets of $500 million or less). In addition to the originators, there is an active secondary market that provides the necessary liquidity to the primary market. The other players that complete the student loan market are guarantee agencies, service providers and collection agencies. Over the last decade, there has been a gradual decline in these loans, especially at the smaller community banks.
The rise in education costs has been faster than the rise in the overall basket of goods over the last 10 years. Increased education costs have been in the 4.5 percent to 7.5 percent range annually since 1998 in comparison to a 1 percent to 5.5 percent range for overall inflation.
Figure 2, from a College Board survey, illustrates the rising trend of college costs for both public and private four-year colleges over time in constant 2008 dollar terms. The costs included in these trends are tuition expenses, fees and boarding costs.
The cost for private institutions has risen at a faster pace than for public institutions over the last 30 years. The published cost at a four-year private institution for the academic year 2008-2009 was an average of $34,132 compared to 30 years ago when it was $15,434 for 1978-1979. The cost for a four-year public school, on the other hand, was much lower: $14,333 in 2008-2009. Since 2000-2001, however, there has been a steep increase in college costs, especially at public institutions. The costs rose by a total of 33 percent, even after adjusting for inflation over this eight-year period. These rising costs put a huge burden on students, especially in today’s slow economy.
The current financial crisis has presented extraordinary challenges for families with college-bound students. As noted earlier, savings and personal borrowings on the part of parents and students comprise the largest share of higher education financing. Borrowing by parents, especially through home equity lines of credit, has diminished significantly as house prices have dropped. Bank lending to consumers for personal expenses, such as college, has also slowed down, especially recently. The overall credit market has tightened, and loan volume has dropped sharply. (One study notes that 60 private lenders originated $19 billion in personal loans in 2008; by the end of January 2009, 39 of these lenders had stopped lending and the rest had tightened their lending standards.)
As a result of this contraction, the Department of Education has seen a 10 percent increase in federal aid applications. Subsequently, Congress introduced legislation in 2008 to keep college financing channels open for families with college-bound students.
The legislation, signed into law as the Ensuring Continued Access to Student Loans Act (ECASLA), contained a variety of measures to ensure higher education financing during the current turmoil in financial markets. It was anchored by a Department of Education-sponsored federal education loan buyback program from private lenders that was meant to inject liquidity in student loan credit markets. The buyback program targeted FFELs, which include the Stafford and PLUS federal loan programs.
FFELs have been very popular in the past. For example, during the 2007-2008 academic year, 7.5 million students and their families took advantage of this type of financing, which totaled roughly $91.8 billion. However, in early- to mid-2008, this market dried up, with major private lenders ceasing to make FFELs due to unprofitability. The loan buyback program was seen as an essential vehicle to get credit flowing in this market again. Subsequent to the initial passage of ECASLA last summer, President George W. Bush signed into law a one-year extension on the buyback provisions so that the Department of Education could buy back FFELs through mid-2010.
ECASLA also allowed for an additional $2,000 to the unsubsidized Stafford loan limit. Furthermore, the bill increased the scope of the Academic Competitiveness Grant (ACG) and the National Science & Mathematics Access to Retain Talent Grant (SMART) so that students who had already been receiving Pell Grants could avail themselves of these additional funding sources. In addition, ECASLA also gave parents the option to defer repayment of PLUS loans to six months after the student finished enrollment at an institution, at least part-time; the bill also expanded eligibility to PLUS loans for parents who were delinquent on medical or mortgage payments.
ECASLA also allows the Department of Education to designate institutions for Lender of Last Resort (LLR) loans upon approval from the Secretary of Education. This provision increases the ability of individual schools to expand student loan access on a systematic basis.
The new Obama administration is also actively working with Congress to ease the burden on families with college-bound students. Just very recently, a new piece of legislation was passed that increases the tax credit for eligible college expenses and increases the grant for low-income undergraduate students.