By: John Sandman
September 23, 2013
Financial literacy has a big influence on borrowers when it comes to basic consumer loans like credit cards and auto loans. The financially literate will err on the side of caution when it comes to running up balances. But a study released last week by the Federal Bank Reserve Bank of New York that looked at credit cards and auto loans taken by borrowers between the ages of 22 and 28 seemed to leave student loans out of the mix.
In "Financial Education and the Debt Behavior of the Young," The FRBNY Consumer Credit Panel (CCP) conducted its study based on quarterly consumer reports it has been collecting from Equifax since 1991. The study included only those with credit reports and analyzed student data on a state by state basis.
"Though each state with mandatory high school financial literacy education maintains slightly different curriculum standards, there are overwhelming similarities in content across state lines," the report said. Seventeen states require that students take a financial literacy course as a requirement to graduate.
The study stated that credit card and auto loans are "debt that is generally used to support consumption, as opposed to student loans and housing debt which generally help individuals accumulate human capital or assets." All in all, the study shows the financial literate were less likely to be creamed by debt.
Student loans, however, essentially fell outside the report's findings. It did not delve into the impact of financial literacy on the decisions people make on student loans.
Meanwhile there is evidence of a lot of financial illiteracy going on at the edges--if not the center--of student lending.
Student loans have increasingly become a decades-long burden that diminishes a borrower's capacity to accumulate wealth. Defaults in public and private loans are rising as the cost of college spikes faster than incomes. A 2009 study "Financial Literacy Among the Young" produced by the Wharton School of Business found "student loans can hinder young people's ability to accumulate wealth," far from being the wealth creation vehicles the Fed study presumes.
Pay-off options for struggling students often challenge the most-financially literate. For example, the Department of Education's Income-based repayment plan (IBR), which reduces monthly costs, is available to any borrower with federal student loans. But the thicket of red-tape borrowers have to navigate is daunting.
IBR payments are based on income and family size. If a borrower's IBR payment is lower than the standard 10-year payment plan, enrollment in IBR will lower the payments.
"If your income rises to the point where your IBR payment equals or exceeds your standard payment, you can stay in IBR, but make the standard payment instead," said Lauren Asher, president of The Institute for College Access last week. "However, at this point, unpaid interest is capitalized, or added to your loan balance." Remaining principal and interest is forgiven, but only after 25 years of repayment.
It was also not clear why the report didn't more closely analyze student loans; the borrower cohort the study was based on included those with credit card and auto loans. Dr. Meta Brown, one of the report's authors, could not be reached for comment.