More than 40 million Americans hold $1.5 trillion of student debt, making it the second largest category of consumer borrowing after home mortgages. The average student debt per borrower was $34,000 in 2016 and graduates of colleges and professional schools, including MBA programs, can easily rack up balances in the six figures.
Economists, as well as Federal Reserve Chairman Jerome Powell, have warned that the student debt burden is hurting the economy by delaying family formation and home buying. That would suggest people who have the biggest debt burdens would hunker down and pay it all off so they can get on with life.
But that’s not happening, according to some recent research by Poets&Quants’ Professor of the Week, Ronald T. Wilcox of the University of Virginia Darden School of Business. In fact, people who have the most debt tend to spend more, too.
STUDENTS OFTEN ‘OVERWHELMED AND DEMOTIVATED’ BY THEIR DEBT
That counterintuitive finding appeared in the paper “The Effect of Student Loan Debt on Spending: The Role of Perceived Payment Difficulty,” co-authored by Yi Zhang of Bridgewater College and Amar Cheema of the University of Virginia’s McIntyre School of Commerce. It was published in the peer-reviewed Journal of Public Policy & Marketing.
Wilcox and his co-authors used extensive data from the Survey of Consumer Finances (SCF), published by the Federal Reserve, to track the spending habits of people who graduated with different levels of student debt. Unlike mortgage or auto loans, which borrowers start paying back as soon as they get the keys to their house or car, paying back student loans is delayed for years, while their balance keeps growing as students finance additional years of education.
Since over 40% of college students “report having no idea of their future monthly student loan debt repayment amount,… students are often shocked by the large lump-sum amount of their debt that is disclosed when repayments commence and can be overwhelmed and demotivated as a result,” the paper notes.
AS LOAN BALANCES GREW, THE MOTIVATION TO CONTROL SPENDING DECLINED
“A difficult but attainable goal motivates people to work hard and stay committed,” the researchers write. “We therefore predict that individuals with moderate (vs. low) levels of student loan debt perceive the goal of paying off the loan to be attainable, and the increase in payoff difficulty boosts commitment to control discretionary spending for these individuals.”
That indeed proved to be the case in the three studies the researchers conducted. But as the loan balance increases, “the debt may eventually seem so high that further increases in payoff difficulty fail to motivate individuals to control their spending,” Wilcox and his co-authors write. “Thus, individuals with high student loan debt may be less likely to control spending relative to those with moderate student loan debt.”
What constitute high levels of student debt? As of 2014, the researchers report, 17% of borrowers left college with $50,000 or more in student loans, accounting for 58% of outstanding student debt. “Furthermore, most of these borrowers have made no progress paying off their student loans in the past four years,” Wilcox and his co-authors point out.
GRADUATES TAKE A ‘WHAT THE HELL’ MENTALITY
That’s where borrowers may fall into a “what the hell?” mentality: Paying off their debt seems so remote they begin to wonder why they should delay gratification in pursuit of an unattainable goal. “Borrowers with high student loan debt are more likely to overspend than borrowers with a moderate level of student loan debt,” the researchers conclude.
They do suggest a possible solution: require all colleges to disclose the monthly payment of loans students take on. When Indiana University began disclosing likely monthly payments to borrowers, it decreased student borrowing by 16% from 2013 to 2015. “Monthly payments provide an easily retrievable reference point that facilitates perception of attainability [and] will motivate borrowers with high levels of debt to exert greater control on spending and thereby reduce these borrowers’ spending propensity,” Wilcox and his co-authors write.
Wilcox, 51, the NewMarket Corporation Professor of Business Administration at Darden, focuses his research on branding, marketing for financial services and nonprofits, and public policy. He teaches required marketing classes in both the MBA and executive MBA program and the elective Pricing class, as well as other courses in several executive education programs.
Having earned his BA in classics and economics from Xavier University, Wilcox went on to get an MS and PhD in business administration from Washington University in St. Louis.