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Economics Faculty Research Yields Valuable Insights on Student Loans and Personal Finance

Posted by on Friday, August 14, 2020 in Research.

Are student loans a smart way to pay for college? Is pawning jewelry ever a good way to acquire extra cash? And why do humans have so much trouble making smart financial decisions? Economics faculty Paige Marta Skiba and Lesley Turner are researching the answers to these questions and providing key insights to help address stubborn socioeconomic issues and behaviors.

Paige Marta Skiba standing in front of a stone wall and flowering tree
Paige Marta Skiba

Skiba, a professor of law and economics, teaches a class on behavioral economics in the College of Arts and Science and a class on law and economics at the Law School. The field of behavioral economics—particularly the question of how people handle high-interest debt—caught her attention after she heard a radio story on pawnshops.

Pawnbrokers interviewed for the story said their best customers were Social Security recipients who returned month after month. These customers often ran out of cash in the last days of the month and would pawn the same item repeatedly to bridge the gap until their next Social Security check arrived. Every time they pawned the item, they would retrieve it a few days later in exchange for a high-interest payment.

“The behavior struck me as reasonable for someone on a fixed income but irrational from a traditional economist’s perspective,” Skiba said. “As economists, we assume people can smooth their consumption to make a single check last a month, but that’s not necessarily the case.”

The research she’s since done on the issue led her to a surprising conclusion: high-interest credit products, such as payday loans, are not inherently bad. Instead, they often serve as an essential, easy-to-understand lifeline for people who need small amounts of money that traditional financial institutions are not willing to lend. According to Skiba, if payday loans disappear, they’re likely to be replaced by credit products that are even more expensive and harder to understand.

At the other end of the spectrum, Skiba also studies complex, long-term financial behaviors, such as saving for retirement or paying down a mortgage. In particular, she investigates the cognitive errors people make in these situations. The biggest stumbling block to smart decision-making? Procrastination. When faced with complex decisions, Skiba said, people often delay to the point of incurring huge personal or financial costs. For instance, she has seen research subjects wait until their 40s or 50s to start saving for retirement because they feel unable to choose between the variety of available account and fund options. As a result, they will retire with tens or even hundreds of thousands of dollars less than if they had begun saving in their 20s or 30s. “I tell my students, ‘Better is the enemy of good.’ Taking some small action, even if it isn’t one hundred percent optimal, is preferable to infinitely delaying and ultimately doing nothing,” she said.

Lesley Turner standing outside
Lesley Turner

Lesley Turner, an associate professor of economics, researches a different kind of complex, long-term financial issue: student debt. Her research focuses on federal student loans and the impact they have on students’ educational attainment and long-term economic well-being. Turner’s interest in conducting research on economic inequality and access to education began when she was an undergraduate research assistant at the National Poverty Center at the University of Michigan. With America’s student debt crisis frequently in the news and the COVID-19 pandemic disproportionately affecting low-income individuals, questions of whether student loans expand or limit access to higher education have taken on a new urgency.

According to Turner’s research, federal student loans can provide a crucial boost to educational attainment, particularly for low-income students—those who are at greater risk of not completing their degrees. When students attending open-access institutions (which disproportionately attract low-income and first-generation college students) take out small federal loans, they often complete more courses and earn higher grades. Turner’s research has also found that, while these students generally increased the amount they borrowed when federal student loan limits were raised in the mid-2000s, they also graduated at higher rates and went on to receive higher earnings in the years immediately after college. The most likely explanation for these effects is that student loans provide a way for students to focus on their education by reducing the hours they need to work for income.

“Given the current structure of higher education financing, students who need funding beyond what’s provided through grants and family savings face the trade-off of taking out a student loan or working while in school. There are benefits to in-school employment, especially if the job is related to the student’s course of study, but hours spent working can’t be spent on coursework or studying,” Turner said.

On the other hand, roughly 10 percent of student borrowers default within three years, and as many as 40 percent default over the lifetime of their loans. These defaults create a ripple effect, lowering borrowers’ credit scores and potentially making it harder for them to achieve key wealth-building milestones such as homeownership. In addition, default rates are higher for Black borrowers than for their white peers, which raises the question of whether student loans may exacerbate existing racial inequalities in wealth. Turner believes some of these issues stem from a lack of awareness about income-based repayment options and from needlessly complex requirements for participating in these repayment programs. Finding other possible causes and their solutions, she said, is difficult because the federal government does not share much student loan data with academic researchers.

Ultimately, she’d like to see the federal government simplify its student loan programs and increase transparency, so academic researchers can help find solutions to high default rates. She also hopes that more universities and government entities will pursue programs like Opportunity Vanderbilt, which provides loan-free financial aid to incoming students. When institutions do what they can to increase educational access, she said, the benefits persist for generations. Her research indicates that, when the federal government increases spending on student financial aid, the investment pays off through recipients’ higher earnings and tax revenue.

“Higher education holds the promise of upward economic mobility and economic security,” Turner said. “It’s one of the most important investments individuals can make throughout their lives.”

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