Interest in financial literacy education has been soaring lately. Each year, hundreds of thousands of people apply to colleges around the country. For those who are accepted, they mostly have to depend on debt to finance that education — the rising cost of tuition makes college unaffordable for many people around the country. There is now around $1.6 trillion of outstanding student debt in the U.S., owed by over 44 million borrowers. This problem has reached crisis level, and a number of presidential hopefuls are staking the future of their campaigns on the strength of their ideas on how to mitigate the student debt crisis — free college and loan forgiveness are two of the most popular proposals.
The decision of whether or not a student takes out a loan to finance their education is one of the most important decisions they will make in their life. Around 69 percent of students from the Class of 2018 took out a student loan and graduated with an average debt of $29,800. But despite the importance of this decision, many students lack access to the data they need to make an informed decision as to whether they should take out a loan, and which loan would be best for them. Taking out a loan or applying for federal aid is seen as an almost necessary part of attending college. Most students who take out a loan do not understand the long-term ramifications of borrowing money through federal and private loans. The solution? The federal government should require mandatory financial literacy courses for high school and incoming college students.
A report published by the Financial Literacy and Education Commission — a committee comprised of the Department of Education and the Department of the Treasury — highlighted the importance of teaching financial literacy to students, especially as student debt becomes an increasingly important problem for students, parents, and the government.
The report suggested that financial literacy courses should be required for students, stating that if these classes are optional, they might not “reach students who may be unaware of them or who do not value the benefits of financial education.” The goal of this recommendation is to ensure that students fully understand the terms to which they are agreeing before they take out a loan, as well as the long-term impacts of student debt. The report also made recommendations around how financial aid offer letters should be formatted. They should include an itemized cost of attendance, accounting for grants and scholarships. And debt letters should become common practice in higher education.
The Benefits of Financial Literacy Education
Teaching financial literacy has a number of benefits. Financial literacy education would help prospective college students better understand what it means to take out a student loan and how student debt will impact their long-term goals. This means that students will be able to make a more informed decision about their education and will be able to evaluate more effectively whether or not student debt is the right option for them.
A 2018 survey by PayScale found that the top regret behind choice of major by college graduates was taking out a loan to finance their education. If students were given more information upfront and were taught how to evaluate the options available to them, it would be less likely that students who take out a loan will regret doing so. They will have been aware of the consequences upfront and will have learned about other ways to finance their education. Ultimately, cost is one of the most influential factors that prospective college students weigh when deciding which college to go to — or, indeed, whether they will be able to attend college at all. Thus, teaching financial literacy is a critical part of helping people make more informed decisions about college and the financing options available.
Financial literacy education may also reduce the default rate of student loans — more than 1 million people default on their student loans each year. Teaching students basic financial skills, such as how to manage their income and track their spending, would help them make better decisions around how much money they will need to set aside to cover their student loans. This would reduce the amount of burden on taxpayers for students who have defaulted on their loans and reduce the stress that students are forced to manage when they default on their loans. According to the 2018 NFCS “State of U.S. Financial Capability Study,” 51 percent of students who owed money in 2018 did not estimate their monthly payments before borrowing money. The report also found that 48 percent of borrowers were concerned about how they would pay off their student loan. If students are taught basic financial skills, it will be easier for them to estimate payments, manage how much money they will need to pay back, and evaluate changes they can make to pay off their student loan earlier.
Teaching financial literacy would also reduce the secondary impacts of student debt on the mental health and decisions of students. A 2018 report from Student Debt Crisis, a non-profit organization researching student debt and advocating for making college free, found that student loan debt has dozens of impacts on the mental health and decisions of students. For example, 80 percent of participants — those who had debt loads of $87,500 versus average annual incomes of $60,000 — said that their student loans prevented them from saving and planning for their retirement. The survey found that 86 percent of borrowers cited student loans as a “major source of stress,” and one-third said that student debt was the top cause of their stress. Another survey by Student Loan Hero found that 65 percent of borrowers lose sleep over how they are going to pay back their student loans.
If students were taught adequate financial literacy, however, some of these problems could be mitigated. Students who are taught financial literacy are able to feel more confident in their finances, and are more likely to make responsible decisions that will make it easier for them to pay back their loans on time. This may reduce the impact of student loan debt on borrowers’ decisions — more borrowers may save for retirement because they are more capable of financing their education. Other reports have also found that student loan debt impacts entrepreneurship and homeownership. These issues could also be mitigated because students who are more comfortable with their finances will be better able to make informed decisions about major life choices, such as buying a home or starting a business.
State Legislation and Mandatory Financial Literacy Courses
Financial literacy courses must be mandatory because, as mentioned above, optional courses will only go so far. Students who are not aware of the programs or who are not interested in the classes would be likely to avoid them if such education was voluntary. A recent report by the JPMorgan Chase Institute found that only 54 percent of student loan borrowers have been making consistent payments, which highlights the importance of teaching financial literacy to as many students as possible.
The recent debate over financial literacy has encouraged colleges and governments to take action. The Council for Economic Education, an organization that promotes financial and economic literacy, found that in 2018 only 17 states require high school students to complete a course in personal finance. However, in 2018, more states started to take action in mandating financial literacy courses for students, which may improve rankings in the Council’s report in the future.
Kentucky passed a law last year that requires students to take courses that meet state financial literacy standards as a graduation requirement; Iowa passed a law last year requiring all high school students starting with the class of 2020 to complete a half-year personal finance course as a graduation requirement. A bill is also being considered in Florida which would require high school students to take a financial skills course covering how to manage their money and the impact of credit scores. Rhode Island and other states are also starting to take legislative action to increase access to financial literacy education.
Teaching Students about Income Share Agreements
Financial literacy courses are not only important to help students manage their debt and make more informed decisions about their education. They are also a necessary part of expanding awareness of new methods of paying for college. Income Share Agreements (ISAs), a form of payment where a student pays a school a percentage of their future income rather than upfront tuition, are one such method being used. Thus far, colleges such as Purdue University, the University of Utah, and Messiah College have started offering ISAs to students; private coding bootcamps and vocational schools such as Lambda School and Kenzie Academy have also followed in launching their own ISA programs.
In an ISA, the amount a student will pay each month will depend on their income — if they earn more, they will pay more. However, if a student earns under a certain amount each month — referred to as the minimum income threshold — they will not be required to make payments until they earn over that amount, or their ISA expires. Payments are also capped at a certain amount to protect high-earners from paying back a disproportionate amount in exchange for their education. According to a 2017 report by the American Enterprise Institute, only 7 percent of students and 5 percent of parents had heard of an ISA. However, when participants in the study were presented with a side-by-side comparison between an ISA and federal and private loans, more than half preferred the ISA over debt.
As more schools launch ISA programs — dozens of vocational schools and universities around the country have launched or are about to launch ISA-based financing options — schools will need to spend more time educating students about how they work. Financial literacy education will be a necessary part of raising awareness for ISAs because they are so new, and many people lack a basic understanding of how the agreements work. Adequate education would also mitigate the spread of misinformation about how ISAs work over the long-term, which would make it easier for students to evaluate their options in greater depth. Financial literacy courses would help alleviate the burden on universities and bootcamps to be the sole teachers of financial literacy for students, and would mean that students would be aware of all of the options available to them before they were asked to make a decision about how to finance their education.
Financial literacy education is not a solution to the student debt crisis by any means. The rising cost of tuition and the increased availability of federal student loans and aid have been major factors that have influenced the rise of student debt, and financial literacy education will not solve these problems. However, financial literacy will go a long way in helping people make more informed decisions about whether they should borrow money to go to college, and will help people feel more confident in their finances. Financial literacy education will also play a key role in helping ISAs become more well-known, which would reduce students’ dependence on debt and mitigate the student debt crisis. Recent action by state legislators, and interest by the Departments of Education and the Treasury highlights increased interest in financial literacy courses, and so in the future perhaps financial literacy education will become more common.