College Debt – Not Just an Issue for Students

The recent economic downturn has Americans thinking very differently about the process of borrowing. In what just might be the silver lining of the current crisis, the idea of creating extensive future debt obligations has both students and college trustees rethinking recently-accepted borrowing practices.

Borrowing for College

The first concern centers upon the amount of debt students have been taking on as they pursue a college degree. While most students have always needed some financial assistance to be able to attend college, the level of debt many students have recently been willing to rack up while in school has truly gotten out of hand.

Today, the median debt load for a student earning a bachelor’s degree is about $20,000 while the average now exceeds $21,000. Most alarmingly, roughly one-fourth of all undergrads borrow more than $25,000 and a tenth borrow more than $35,000.

If the choice is made to attend graduate school, then students generally add tens of thousands of dollars to the accrued debt. Depending on the graduate degree program students pursue, the current average debt for graduate degree students ranges from $42,000 to more than $125,000.

However, a student loan for school is often referred to as “good” debt because it is an investment in one’s future The reason is simple, upon earning a college degree, you will have the chance for a better job and far greater earnings than a person without a degree.

But many students are starting to realize that those greater earnings still may not be enough to pay off the debt incurred while securing that degree. All too often, students are finding their debt obligations from school eating up such a large portion of their pay check that purchasing a home or starting a family is beyond their financial means.

Colleges Borrowing

On the flip side of student’s borrowing, it seems that colleges themselves have also been incurring significant debt in recent years. Now, amidst the current economic downturn, some colleges face financial perils.

According to the folks at The Chronicle of Higher Education, “June 30 could be a day of reckoning” for many colleges. What makes the issue so compelling is this day of reckoning is one that most never saw coming.

Effectively, the competitive rush for top shelf facilities led many schools to borrow tens of billions of dollars over the past ten years. With their borrowing, many schools created extensive debt obligations against the potential for future earnings.

However, the financial downturn has made it tougher for students to attend school and thereby has greatly reduced projected future returns. At the same time, in the process of borrowing funds, colleges used the existing value of their facilities and endowments as asset collateral. Here again, the recent downturn has greatly reduced the value of these assets.

With large liabilities accompanied by shrinking assets, some schools are now finding themselves in violation of specific bond or loan requirements. At the same time, with banks and lenders under pressure, cash-strapped colleges are not as likely to be given forbearance should it be requested.

According to the Chronicle, the result could create a situation where bondholders subsequently “demand immediate repayment on part or all of an institution’s bonds.” In addition, in the cases of a school facing variable-rate debt obligations, those institutions holding a loan could legally hike the interest rate exacerbating the debt repayment challenge.

To repay these loans on the quick, schools must then turn to their endowments for cash, a factor that then further reduces their assets and thus increases their debt to asset ratio.

Beyond the debt obligations themselves, strapped schools could ultimately violate the eligibility standards set by the U.S. Department of Education for federal student aid. Any college so indebted as to lose eligibility to receive federal student aid would soon find its enrollment falling through the floor. That drop in enrollment would further exacerbate the debt repayment issue to the point that the school would have to cease its operations.

Carefully Consider Any Debt Contract

Any incurred debt carries with it an expectation of repayment, plus some additional cost (interest). Debt also generally requires some type of collateral in case the borrower defaults on the repayment expectations.

It is extremely important that students understand that debt is ultimately a claim against future labor and earnings. The borrower essentially gains something immediately but in turn makes a pledge to pay for that something down the road.

The recent economic downturn has hopefully taught many people a great lesson. First, as many have recently found, there is no guarantee that those future earnings will in fact be enough to meet the debt commitment. Second, if you default on that commitment, you will lose your collateral as well as your credit rating.

The number of home foreclosures and businesses filing for Chapter 11 combined with the current issues facing institutions of higher learning serve as a great reminder to us all: entering into debt is not to be taken lightly.

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