More Than Tuition: Improving Financial Literacy

After colleges set their Cost of Attendance (COA), financially needy students often have to confront a difficult question: how much debt can they afford to take on? Cash-strapped students obviously don’t want to take out more debt than they need. But they also have to be careful about under-borrowing—taking out less money than they need to succeed academically. Improving financial literacy for these students is a critical task.

Creating a budget that reflects how much to borrow for college is complex. It requires students to trade off their current and future consumption without any semblance of certainty about how much they will earn when they have to repay their debt. While most people easily understand the value of having additional income today, they often do not understand the full costs of taking on that same debt until much later in life. At times, even predicting current financial needs can be difficult if unexpected circumstances arise. 

At the same time, fear of taking on student loan debt is widespread, particularly among low-income students. Those who try to avoid it often have to work long hours off campus, making it difficult for them to keep up with their studies and sometimes leading them to give up on their college dreams altogether. Indeed, a Federal Reserve survey of young adults estimates that of people who are interested in attending college but have not yet enrolled, 63 percent listed not wanting to take on debt as a key barrier to doing so. 

Because students are both at risk of borrowing too much, or worse, not enough, designing student aid packages that effectively use behavioral research in ways that help students is anything but straightforward. For example, we know that the way students' financial aid packages are set up can ultimately influence how much they borrow. If loans are included in student aid packages, these students might be inclined to borrow their full COA. On the other hand, leaving loans out of financial aid packages might dramatically lower the amount the average student borrows. But which of these outcomes is ideal ultimately depends on the impact they have on a student's academic success and eventual repayment. 

The University of Virginia's Ben Castleman has given education experts a few rules of the road when it comes to nudging students. Most importantly, he recommends giving students an active role in the decision-making process and not relying on overly prescriptive solutions. When it comes to loans, this would mean helping students evaluate the tradeoffs of additional borrowing, rather than simply encouraging them to borrow less. The key is to provide customized, understandable information to students about the impact of borrowing decisions both immediately and over the long run. 

The U.S. Department of Education’s introduction of the Financial Aid Shopping Sheet in 2012 was a key starting point towards improving students' access to meaningful financial information. This voluntary approach aims to standardize the financial aid packages students receive from colleges and is intended to help students more easily compare aid offers from different institutions. Unfortunately, fewer than half of Title IV participating schools are currently using the Shopping Sheet. Worse still, some of the statistics presented on the Shopping Sheet may be actively misleading. As we learn more about the behavioral economics of award letters, the Department should consider regularly updating the Shopping Sheet to reflect current knowledge. 

Colleges might also want to consider providing regular updates to students regarding how much they’ve borrowed, their estimated monthly payments after graduation, and how close they are to the aggregate borrowing limits. Legislators in Nebraska approved a bill this spring that requires the state's public colleges and universities to take such an approach to help students make more-informed borrowing decisions and provide them with a clearer picture of how their debt will impact their future financial success. However, high levels of debt can often be scary for many students, which may jeopardize completion. Helping these students navigate acceptable levels of risk is not a one-size-fits-all formula—policymakers should seek out approaches that strike this balance while institutions should help students develop personalized borrowing strategies that reflect their needs. Providing transparency in these cases is still important, but institutional leaders should help students understand both the risks and potential rewards from borrowing. Information on aggregate debt should be provided alongside an estimate of typical earnings, as well as repayment options to help reduce anxiety and help students make good investments. 

Overall, what we currently know about behavioral economics  and consumer financial education might not be enough to design foolproof financial aid delivery models. However, as the field unfolds, the implications for student borrowers could be profound. A better understanding of the psychological implications of the content, context, and mode in which information is presented could help individuals make better borrowing decisions, even when faced with complexity and uncertainty about the future.