A Novel idea? Apply Basic Financial Literacy Concepts to Paying for College

Mission control, we have a problem. Why does it seem that too few families apply even the most basic financial concepts when planning to pay for college – one of the biggest purchases they will ever make? 

There is no ubiquitous answer. The plan to pay for college is unique to each family, just as each has its own earning and asset profile –not to mention differing levels of financial sophistication. The process is unfamiliar, jargon-laden and heavily influenced by politics. But that doesn’t mean financial illiteracy should be the result.  

Instead, financial literacy experts can use the process of planning to pay for college as an opportunity for a lifelong learning exercise in financial literacy for all family members, whether adults or children. 

How? First, let’s take a quick look at current financial literacy standards and then compare them to the realities of planning and paying for college to show opportunities for improvement.

Financial Literacy Standards

Much financial and intellectual capital has been spent creating standards for financial literacy. None more practical than those created by an impressive cross-section of experts under the leadership of the Council for Economic Education. Their report “Financial Standards for Financial Literacy” notes that decision making is at the heart of economics (direct quotes from the report are italicized). The decision-making skill is divided into three steps:

·     Planning and Goal Setting

·     Making Decisions

·     Assessing Outcomes

The report also provides grade-based benchmarks for each of the following six standards. Note that each involves making decisions and choices – the heart of economic choice.

1.    Earning Income: The decision to undertake an activity that increases income or job opportunities is affected by the expected benefits and costs of such an activity.

2.    Buying Goods and Services: People can improve their economic well-being by making informed spending decisions, which entails collecting information, planning and budgeting.

3.    Saving: People make different choices about how they save and how much they save.

4.    Using Credit: People choose among different credit options that have different costs. Lenders approve or deny applications for loans based on an evaluation of the borrower’s past credit history and expected ability to pay in the future.

5.    Financial Investing: Financial investment is the purchase of financial assets to increase income or wealth in the future. Investors must choose among investments that have different risks and expected rates of return.

6.    Protecting and Insuring: People make choices to protect themselves from the financial risk of lost income, assets, health, or identity. They can choose to accept risk, reduce risk or transfer risk to others.

College Planning Realities Don’t Align Well with Financial Literacy Standards 

The Standards are logical and rational for consumers purchasing most goods and services. Unfortunately, some or all of the following realities of planning to pay for college contribute to families wandering away from these best financial literacy practices – often because they feel that they don’t have the power to choose.

1.    Emotion often overwhelms the process: Chasing the dream of college and an over- reliance on governmental and institutional financial support systems tend to result in families forgetting that they are consumers of education. Many blindly conclude that all will end well. After all, it has to. Right? Wrong. Just look at the statistical evidence (more than $1.3 trillion of student debt, double-digit student loan default rates) and the anecdotal evidence (news stories of some students owing multiples of what then earn). Something’s not right.

2.    The investment time horizon is relatively short: Most traditional students enter college near their 18th birthday. Somehow, despite having all these years to prepare, families delay planning for college until the last minute – often junior or senior year of high school. Why? When children are very young, new parents are often juggling many financial priorities – building a rainy-day fund, purchasing a house and/or car, saving for retirement. They discount the value of longer-term financial compounding – earning interest on interest over many years – and often give away five or more critical years of compounding under the false impression that they have plenty of time to save for college. It’s easy to underestimate how quickly fifteen years will pass when you are changing diapers.

3.    Misinformation abounds: The internet is a blessing and a curse: lots of information, but not all of it current, relevant or accurate. I want to scream every time I read – from credible sources – any number of dumb ideas related to planning to pay for college. Here are a few of the worst ideas:

a.    Buy a vacation or second home. Enjoy or rent it while your children grow, sell it to pay for college.

b.    Borrow from your 401(k) plan to pay for college because you pay yourself back the interest on the loan.

c.    Don’t save for college, because you will be penalized in the financial aid process.

d.    Don’t save for college, because colleges will make sure you get enough aid to attend.

4.    The investor may not be the decision-maker: Parents, grandparents and other contributors (the investors) to a student’s college savings do not directly benefit from their investment and, often, do not have control over how their hard-earned money is spent.

Let’s overlay these realities on CEE’s Financial Literacy Standards:

1.    Earning Income: Name a large purchase decision in which the purchaser agrees to buy a product without knowing the exact cost or what the benefit will be?  Did you say college?  Upon matriculation, usually only the first year cost is locked in and there is no certainty of the outcome (i.e. income).   I’ve met many highly educated, rational, responsible parents who tell me they will take on large amounts of debt for their child to attend the “right” college of their dreams – without ANY consideration of the cost/benefit outcome. The reality of needing income to justify the expense is simply overrun by emotion.

2.    Buying Goods or Services: Applying the concept of improving economic well-being by collecting information, planning and budgeting to make an informed spending decision is challenged out of the gate when planning to pay for college. Why? When buying most products, the sticker price may be subject to some negotiation, but is generally known. Not so when purchasing education. The sticker price of a college is reduced for nearly all students by the amount of financial aid offered, which can be a lot or very little, and seems to be calculated in a black box on a family-by-family basis and is unknown until very late in the purchase process. It’s not like purchasing a car. If I know my neighbor was able to buy a car at a certain price, I have a reasonable expectation that I too would pay about the same price. For college, there is no similar gauge, so families should not eliminate a particular college based solely on sticker price. Their price - the net price - may well be significantly less than the sticker price.

3.    Saving: Choosing to save for college can be hampered by confusion about how – and how much – to save. It’s difficult to determine fifteen years in advance, how much savings will be necessary because of the many unknowns: price, choice of college (in or out of state, public or private, four-year or two-year?), future inflation rates, living on- or off-campus, the amount of available financial aid. The best practice is to save as much as is reasonable in the most flexible savings vehicles available. For college-bound families, there's one best practice: start saving now.

4.    Using Credit: CEE’s standards are dead-on accurate for credit in all markets – except student loans. The federal government makes more than 90 percent of all loans to college students. Unlike traditional credit markets that charge interest rates based on risk, the federal government does not test students for credit when pricing loans: All borrowers pay the same rate. The feds also offer loans to parents. Unlike the student loan, parents have to meet a minimal credit test, but it is bare-boned and not close to standards used by banks. Without regard to their credit profile, all parent borrowers also pay one interest rate. It’s ironic that Uncle Sam’s loan program – likely the very first experience young adults have with credit – violates the most basic concepts of lending, prudent use of loans and fundamental financial literacy concepts.   

5.    Financial Investing: Investing in college is arguably not a financial investment from the perspective of determining risk and reward of a financial asset. However, it is an investment from the perspective of using savings, current income and credit to produce a higher future income. One could look at investing in college as purchasing an annuity – without knowing the future payout – not a best practice in the world of financial literacy.

6.    Protecting and Insuring: The process of evaluating risk and insuring against it is another basic concept of financial literacy that is not evident in the process of planning to pay for college. Ultimately, the greatest risks to consumers of education are non-completion, underemployment and/or overpaying for a degree relative to the economic benefit derived. Currently, consumers do not have an option to purchase insurance policies to mitigate these risks. However, some colleges are beginning to help with innovative programs that may (a) pay some or all of an under- or unemployed graduate’s loans, (b) make loans with repayment plans that are tied to future income or (c) offer additional free education, if a graduate does not get a job in their field. Finally, colleges are beginning to put skin in the game to compete for students by offering their graduates some level of insurance against these risks.

Opportunities

Early on a Saturday morning in December 2017 as the region’s first snow was falling, more than 125 financial literacy experts gathered at Rhode Island College to discuss CEE’s Standards and practical applications at the 4th Annual Financial Capability Conference sponsored by the Rhode Island Council for Economic Education and Rhode Island Jump$tart. Among other things, we explored ways to seize the opportunity to use the process of planning for college as a lifelong case study in the pursuit of family financial literacy. Here are a few of the observations and concepts we discussed:

1.    Financial literacy is a family activity. Many times, financial literacy programs are separately designed for children/student and parents. Let’s use the process of planning for college to teach financial literacy to parents and children alike. The opportunity: Complement CEE’s 4th, 8th and 12th grade benchmarks with grade-by-grade action plans for parents and children to learn basic financial literacy concepts together with an eye toward college. For example, have young elementary school students specifically save for college as a goal. As they age, they can then choose specific colleges, see the cost and understand the choices they can make to find an affordable college when the time comes.

2.    Starting a savings program early is significantly better than waiting - take advantage of compounding to grow education savings. The opportunity: For parents, illustrate concepts such as the time value of money and compounding by creating a plan to pay for college for each student individually and the family holistically. Children/students can be engaged at an age-appropriate time.

3.    Planning to pay for college does not require a comprehensive strategy paper – just some focus and knowledge of the options of how to pay for college as early as middle school. The opportunity: Introduce a specific exercise in which students and parents select college options, do a mock expected family contribution and then meet their expected family contribution for each school.

4.    For high school families, reinforce the affordability criteria - link the college application process and outcome (a job or graduate school). The opportunity: Engage families interactively to prepare them to apply for admission and financial aid, and then how to compare net prices to select an affordable college that is a good academic and social fit and provides the best opportunity for a reasonable outcome.

Hopefully, this article will help start a more productive dialog leading to a solution to the student loan debt and college affordability crises. Financial illiteracy should not be a fait accompli for college-bound students.

Please send reply to this article or send me your thoughts: [email protected].

John Hupalo is the founder and CEO of Invite Education, co-author of “Plan and Finance Your Family’s College Dreams” (Petersons, 2016) and host of the My College Corner podcast.