By: Liz Strait, PhD
Introduction
Student loan repayments are set to restart by August 29th, 2023. The resumption of student loan payments has many Americans anxious about how they are going to cover monthly costs. In a survey conducted less than a year ago, 60% of student loan borrowers stated they wouldn’t be able to afford their loan payments should they resume.2 The return of student loan payments has ramifications across many layers of American society—parents who are trying to save for their children’s higher education while paying off their own, older borrowers approaching or in retirement trying to balance student loan debt with a fixed income, and current high-schoolers trying to decide if a four-year degree provides the return it once did.3,4
Background
In March 2020, student loan payments were put on pause due to the negative financial effects of the COVID-19 pandemic. For over three years, American student loan borrowers have not been required to pay any monthly amount towards their debt (and most borrowers chose not to). Since that time, the end to this student debt forbearance has been announced, and subsequently changed, nine times. The most recent expiration date is August 29th, 2023 (at the latest—it could be sooner should SCOTUS reach a decision on potential debt cancellation before June 30th, 2023).1 This lack of clarity only further exacerbates the financial stress borrowers may be feeling.
Many borrowers—60% according to one survey—indicate they will not be able to afford their payments. A full 88% of borrowers express some level of uncertainty about their ability to cover their monthly loan bill.2,5,6
Student loans are not limited to younger adults. One percent of the US population over 60 has student loan debt. Federal borrowers aged 50-61 owe $44,031 on average.
The inability of many borrowers to pay their monthly debt is caused by several factors including increases in the cost of other debt7, inflation, and the increased cost of living. Forty-five million Americans (over 17% of the population) currently hold student loan debt.2 This means the effects of student loan debt repayment, potential delinquency and defaults, and reduced spending will have sweeping effects that go beyond just borrowers.8
Psychological Factors
There are many psychological factors and biased decision-making strategies at play when borrowers consider the uncertainty around debt repayment, increased financial constraints, and the potential inability to reach financial goals. A major one, which has been discussed in our previous posts, is emotions. In addition to these emotional responses, there are also three findings from behavioral finance that can inform clients’ behavior during this time.
Mental Accounting
Clients will treat money in different accounts differently, violating the strong economic assumption of the fungibility of funds. This means that clients may be unwilling to move money from one account (e.g., savings, usually the most sacred of all accounts) to another (e.g., spending). Therefore, clients may avoid dipping into savings to help cover their increased monthly costs. Some clients may even take out more debt to avoid touching savings or other money set aside for specific purposes.
Intertemporal Choice
Almost everybody struggles with self-control in at least one domain. Even clients who exhibit self-control around finances may struggle with self-control around time and effort. For those who struggle to stick to a budget or save, repayment could result in increased debt and financial insecurity as these clients are unable to adjust to their reduced monthly income. Clients who struggle with procrastination or exerting costly effort may be overpaying for their debt since enrolling in debt reduction programs requires time, diligence, and cognitive effort.9
Scarcity Mindset
One of the most interesting and impactful findings related to financial decision-making in recent years is that scarcity (defined as the gap between one’s needs and the resources they have available to meet those needs) causes a reduction in cognitive capacity (by approximately 13 IQ points). An important implication of this work is that removing financial scarcity can change a person’s mindset and return them to normal levels of cognitive functioning. A scarcity mindset will change what clients notice, how they weigh their options, how they think, and what they ultimately decide. Individuals experiencing scarcity mindsets have been found to have lower self-control, lower executive functioning, less insight into their behaviors, and less concern for the future.
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End Notes
[1] Haverstock, E. (May 19, 2023). "Forgiveness, Forbearance and Other Student Loan Changes to Know." Nerdwallet. https://www.nerdwallet.com/article/loans/student-loans/forgiveness-forbearance-and-other-student-loan-changes-to-know
The Administration and the Department of Education have assured borrowers this deadline will be enforced, but previous end dates were similarly emphasized. This history of backtracked timelines has only served to create uncertainty and confusion—borrowers are not only uncertain of whether their forbearance will actually end, but also whether debt cancellation will be enacted.
[2] Morning Consult. (2022). National Tracking Poll #2208182. https://pro-assets.morningconsult.com/wp-uploads/2022/10/10145326/2208182_crosstabs_MC_FINANCE_STUDENT_LOANS_Adults_STACKED_v1_CC.pdf
The average borrower holds $29,000 in student debt, resulting in average payments between $200-299 per month. One percent of the US population over 60 has student loan debt. Federal borrowers aged 50-61 owe $44,031 on average. This is not a small amount for individuals on the precipice of retirement. As a result, these borrowers are contemplating whether they can retire and what that retirement will look like—paying $400-500 per month on a fixed income is not feasible for many older Americans. Student loan debt has also affected Americans aged 30-45, the age group that owes nearly half of all student debt. Many of these individuals are considering having children or already have children. That means that most student loan borrowers will soon be balancing saving for their children’s higher education costs while paying off their own.
[3] Selingo, J. & Sigelman, M. (May 20, 2023). "Yes, a College Degree is Still Worth It." The Wall Street Journal. https://www.wsj.com/articles/yes-a-college-degree-is-still-worth-it-6a7bfe7b
[4] The Burning Glass Institute. (2023). "The Emerging Degree Reset." https://www.burningglassinstitute.org/research/the-emerging-degree-reset?mod=ANLink
[5] Berman, J. (May 22, 2023). "After the pause: This is how borrowers are preparing for resumption of student-debt payments." MarketWatch. https://www.marketwatch.com/story/after-the-pause-this-is-how-borrowers-are-preparing-for-resumption-of-student-debt-payments-3b4d016c
This represents approximately 2% of each borrower’s discretionary income.
[6] Helhoski, A., Lane, R. & Haverstock, E. (May 2, 2023). "Student Loan Debt Statistics: 2023." Nerdwallet. https://www.nerdwallet.com/article/loans/student-loans/student-loan-debt
Ten percent of student loan borrowers owe $80,000 or more.
While the bulk of the student loan debt is owed by those aged 35-49 ($600 billion), borrowers span all generations.
[7] Conkling, T. & Gibbs, C. (Nov 2, 2022). Office of Research. "Update on student loan borrowers during payment suspension." Consumer Financial Protection Bureau. https://www.consumerfinance.gov/about-us/blog/office-of-research-blog-update-on-student-loan-borrowers-during-payment-suspension/?mod=ANLink
Forty-six percent of borrowers have seen their monthly payments on credit cards and car loans increase by at least 10%.
[8] Fidelity Investments. (2022). 2022 College Savings Indicator. https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/about-fidelity/FidelityInvestments2022CollegeSavingsIndicator.pdf
In their 2022 College Savings Indicator survey, Fidelity found that 30% of parents with student loan debt have not started saving for their child(ren)’s education, and 35% of parents planning to pay for at least some of their child(ren)’s education don’t have any financial plan in place. This raises concerns about the amount of debt future generations will be saddled with, perpetuating financial insecurity and stress as a result.
[9] Turner, S. (Apr 13, 2023). "Student loan pause has benefitted affluent borrowers the most, others may struggle when payments resume." Brookings Institution. https://www.brookings.edu/2023/04/13/student-loan-pause-has-benefitted-affluent-borrowers-the-most-others-may-struggle-when-payments-resume/
There are currently several programs in place to provide relief to qualified borrowers (e.g., income-based repayment and loan forgiveness). However, the number of individuals enrolled in any of these programs has increased only minimally since the pandemic began.
[10] Mani et al. (2013). "Poverty Impedes Cognitive Function." Science, 341(1), 976-980. https://www.science.org/doi/10.1126/science.1238041
This is because our minds automatically orient toward our unfulfilled needs—changing how we think at a subconscious level (i.e., we don’t choose to be consumed with these needs, we just are).
Caetano, G., Patrinos, H.A., & Palacios, M. (2011). "Measuring Aversion to Debt: An Experiment among Student Loan Candidates (Policy Research Working Paper No. 5737)." The World Bank. https://elibrary.worldbank.org/doi/abs/10.1596/1813-9450-5737
Helhoski, A. (Jul 14, 2022). "Can Student Loan Borrowers Handle Payments and Inflation, Too?" Nerdwallet. https://www.nerdwallet.com/article/loans/student-loans/can-student-loan-borrowers-handle-payments-and-inflation-too
Lonas, L. & Gangitano, A. (May 17, 2023). "Pause on student loan payments about to end for millions." The Hill. https://thehill.com/homenews/education/4006848-pause-on-student-loan-payments-about-to-end-for-millions/
Mullainathan, S. & Shafir, E. (2013). Scarcity: Why Having So Little Means So Much. Macmillan.
Shah et al. (2012). "Some Consequences of Having Too Little." Science, 338(1), 682-685. https://www.science.org/doi/10.1126/science.1222426
Thornton, D. (May 19, 2023). "Will the Supreme Court strike down student loan forgiveness?" CNBC. https://www.cnbc.com/2023/05/19/will-the-supreme-court-strike-down-student-loan-forgiveness.html