Millions of student loan borrowers owe a collective $1.7 trillion in debt, but many commit to loans without knowing what they are signing up for, research shows.

Students lacking education in personal finance are more likely to underestimate future student loan payments, wrote Nikolaos Artavanis of Virginia Polytechnic University, and Soumya Karra of the University of Massachusetts.

Nearly 40% of borrowers who said they lacked understanding of how loans work underestimated their future payments by more than $1,000 a year, the researchers wrote in The European Journal of Finance in January 2020. Understanding their future financial commitment corrected their estimates by 17-18 percentage points.

And some borrowers concluded that although the educational benefits outweighed the disadvantages of taking on student debt, they would have borrowed less if they had understood the financial and mental strain those loans caused.

Student debt is a flashpoint for many Americans and a cause among politicians.

President Joe Biden has allocated $40 billion to help students with debt, emergency relief, tuition and housing.

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Democratic Senator Elizabeth Warren and independent Senator Bernie Sanders have been vocal proponents of debt forgiveness for student borrowers.

How do students rack up debt?

Tuition and fees have been on the steady increase since the 1980s when state funding for higher education began a steady decline. Between 1995 and 2014, average annual borrowing by undergraduates increased about 75%. Among graduate students, average annual borrowing grew by 110%, according to a January 2020 Brookings Institution report.

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While more than 40% of student loan borrowers leave school owing $20,000 or more, according to the Consumer Financial Protection Bureau (CFPB), Brookings has warned about attributing student debt as widespread.

In the student-loan landscape, 30% of undergraduates leave school with no debt and about 25% with less than $20,000, Brookings said.

“Despite horror stories about college grads with six-figure debt loads, only 6% of borrowers owe more than $100,000 — and they owe about one-third of all the student debt,” Brookings wrote.

And that 6% who owe more than $100,000 are typically borrowers who earned advanced degrees. Households with master’s, doctoral or other graduate degrees owed more than half of the outstanding education debt, Brookings reported in October 2020.

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Medical school — which can cost $200,000 a year — is a prime example of a student borrower who owes massive amounts of debt.

Who needs the most help?

A lack of financial literacy is seen among first-generation students — the first in their families to go to college or university — and women, among all borrowers.

Of the nearly 40% in the Artavanis and Karra study who did not understand how the loans and their repayment worked, 33% were first-generation students, 26% were women, and 24% were minorities.

First-generation students lacking financial literacy are further hindered by language and culture to interpret and navigate student loan options and practices, according to Brookings.

Borrowers of federal loans are increasingly likely to be first-generation students, and first-generation borrowers were the most likely to default under crushing debt burdens, Brookings reported.

In the gender divide, a study by Lu Fan, assistant professor of personal financing at the University of Missouri, Columbia, and Swarn Chatterjee, professor of financial planning at the University of Georgia, in 2018 showed that women are less likely to be late on loans, but more likely to stress about it than men. Men are less likely to worry, even with a higher likelihood of being late on student repayments.

Younger borrowers showed the least financial knowledge, as did borrowers from underrepresented or lower socioeconomic backgrounds, according to Brookings.

Educating student borrowers

When students graduate or drop out of university, they have six months before they have to make payments on federal loans: 91.8% of student loans are issued by the federal government.

In 2020, approximately 20% of borrowers defaulted — or did not make a loan payment for 270 days — in the United States, according to a report by the Pew Research Center.

Even with various loan repayment options tied to income, such as Income-Contingent Repayment (ICR), Income-Based Repayment (IBR), and Pay as You Earn (PAYE), borrowers have reported they have not been informed of these options and have often gone to pay high monthly payments as a result, according to Fan and Chatterjee’s study.

“It is possible that adding a financial literacy component to the student loan repayment program could help the borrowers in making more informed student loan payment decisions in the future,” explained Fan.

Increasing financial technology education will have a positive impact on enhancing financial capability and increasing financial literacy, according to a study done by Georgios Panos of the University of Glasgow, and John Wilson of University of St. Andrews.

The researchers noted that financial literacy is important in maintaining a sound financial security and suggested that differences in financial learning acquired early in life, “can explain a significant part of financial and more general well-being in life.”

“In an era of mounting student debt, increased (digital) financial inclusion, and threats arising from instances of (online) financial fraud, financial education and enlightened financial advising appropriate policy interventions that enhance financial and overall well-being,” explained Panos and Wilson wrote in The European Journal of Finance in January 2020.

To encourage more financial literacy among borrowers, states have adopted changes in their legislation to encourage financial education, according to a 2020 report by the National Conference of State Legislatures. For instance, Arizona enacted a bill that allows a course in financial literacy to qualify as work activity. Additionally, Arizona has also appropriated $1 million to fund the provision of personal finance courses to high school students before graduation.