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The Effects of Loan Aversion on Student Success

1504 words (6 pages) Essay in Education

18/05/20 Education Reference this

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The Effects of Loan Aversion on Student Success

Stephanie Peters

University of Central Florida

The Effects of Loan Aversion on Student Success

Those students who are incapable of financing their schooling often turn to financial aid for assistance; however, many students avoid college altogether for fear of student loan debt accumulating, as they are unable to pay for it out of pocket. This reluctance to take out loans is known as loan aversion and is becoming a widespread trend across the nation. Research suggests that loan aversion is directly related to a student’s risk aversion to defaulting on their loans. This paper seeks to explore the extent to which the role of financial literacy, or a student’s ability to utilize financial resources efficiently, effects a student’s willingness to go to and remain in college (Herzog, 2018). The synthesis of three ideas – financial loan aid influence on retention in college, the extent to which loan aversion exists, and factors that lead to students’ willingness to take out loans – indicate that a student whose understanding of the role of financial aid has the ability to borrow more responsibly and are increasingly more likely to invest in a higher education, as well as remain in college after two years (Boatman, Evans, & Soliz, 2017; Herzog, 2018; Menges & Leonhard, 2016).

Some students begin to learn about financial literacy as early as high school, such as in an economics or finance class; however, not at all high schools offer courses of this nature. Most colleges and universities are aware of the importance behind educating students of the options available to them in terms of financial literacy. They allocate resources strictly dedicated to enabling students with the knowledge and ability to make educated decisions when it comes to their personal finance and money management. These resources, such as a financial assistance office or a financial aid counselor, serve to guide students in “making prudent decisions about financial aid and help them plan for the future” (Menges and Leonhard, 2016). Financial guidance is even more likely to have a profound effect on success on students from low-income backgrounds, as indicated by research done by Herzog (2018).

To further demonstrate this, Herzog’s study examined the extent to which student loans aided a student or proved to be detrimental in their college retention.  His results showed that though the “estimated effect of loan aid on student persistence varies with the ability to pay for college,” those students who a) are Pell Grant eligible (i.e., low-income backgrounds) and b) take-up higher quantities of aid are at a higher risk of dropping out of college after their first year (Herzog, 2018). This risk comes at an even greater threat to those who borrowed the maximum amount of subsidized loans allowed per year to cover their costs. Yet, according to a study done by Menges & Leonhard (2016), there is not yet enough conclusive evidence as to whether or not loans are positively associated with the acquisition of a college degree. Herzog maintains that loan aid reduces an institution’s first-year retention by a minimum of one percent, suggesting that because the “negative effect of loan aid is limited to students least likely to afford college” and consequently take out larger amounts, that institutions should seek ways to reduce the costs of attendance for these students exclusively. Furthermore, institutions are encouraged to improve the amount of academic support offered to these students, given that academic performance has a greater impact on these students’ retention (Herzog, 2018).

These suggestions are shared by the research of Menges & Leonhard, who contend that financial literacy was among the variables in their study that corrected directly with a student’s willingness to borrow from financial aid. Their study examined many of the different factors that may affect this willingness to borrow but found that rather than sociocultural variables being responsible for the lack of financial literacy and borrowing patterns, that “unique individual differences” may be the culprit (Menges & Leonhard, 2016). The findings indicate that though “ethnicity and culture do not strongly influence decisions about student loans,” their findings may point to a greater financial need among African-Americans, as shown by the fact that a greater number of students in this subgroup had already borrowed loans at the time of the study being conducted. Because of this, it is implied that African American students are at a greater risk of being financially vulnerable; however, not borrowing can leave students just as financially vulnerable. Menges & Leonhard also assert that “choosing not to borrow a student loan … can negatively impact a student’s chance of reaping the financial benefits of a college degree” (Menges & Leonhard, 2016). This illustrates the circumstance of underinvesting in higher education.

Previous studies have cited loan aversion as the cause of this underinvesting in students across the nation, yet empirical evidence to support these claims have been lacking. Very few studies have qualitative and measurable data to provide insight onto what loan aversion is and how it affects college enrollment. Boatman, Evans, & Soliz, (2017) conducted a study delving into understanding loan aversion serves to provide empirical evidence to the theory of loan aversion. The findings illustrate the relationship between loan aversion and risk aversion; that is, loan aversion is understood to be an extreme transfiguration of risk aversion stemming from the fear of defaulting on student loans. The systematic reasoning of an excessively risk aversive student portrays the decision to take out a student loan as resulting in a negative outcome, making the student increasingly more reluctant to do so (Boatman et al., 2017). The remedy to this comes as a similar solution to the previous works. To counter loan aversion, providing students with resources, such as methods of income-based repayment, can ease the tensions of student loan default. Much like Herzog (2018) suggested, finding alternatives to reliance on loans to finance education is in an institution’s best interest. For example, tuition subsidies and grant aids can effectively minimize the need to take out student loans. Another method, used by wealthier intuitions, is one in which grant aids of a large sum are used in place of loans in financial aid packages (Boatman et al. 2017).

The combination of ideas from these three pieces serve to form a common hypothesis that a student who is unwilling to take out or borrow from student loans is increasingly more likely to either not attend college or terminate their course of higher education. Financial loan aid influence on retention in college, factors that lead to students’ willingness to take out loans, and the extent to which loan aversion exists all converge at the agreement of financial literacy being the solution to preventing this from happening. Herzog (2018)’s research proved that taking out student loans may very well prove to be detrimental, supporting Boatman et al. (2017)’s indications of risk aversion, of which states that a student who is more risk aversive than that of his peers sees taking out student loans as potentially harmful and consequently avoids taking out loans. Menges & Leonhard (2016)’s research connects all three works by providing a conclusion that states that a student’s willingness to borrow directly stems from the student’s amount of financial literacy. As a result of this conclusion, it is imperative that emphasis is put on educating current and future college students on financial literacy, more specifically on African Americans and students of low-income backgrounds. This includes students knowing exactly what their resources are and how to access them, as “increase[ing] levels of financial literacy may improve students’ abilities to understand the loan process and borrow responsibly” (Menges & Leonhard 2016). For those students who fear defaulting on their loans, being educated on repayment programs can assist them in “mak[ing] more informed decisions regarding borrowing money for college, potentially leading to higher rates of college-going and degree attainment” (Boatman et al. 2017). Another solution, as suggested by Herzog (2018) and Boatman et al. (2017) is seeking other alternatives to minimize the amount of borrowing a student does, thus maximizing the opportunity for retention in college.

References

Boatman, A., Evans, B. J., & Soliz, A. (2017). Understanding loan aversion in education: Evidence from high school Seniors, community college students, and adults. AERA Open, 3(1). Retrieved from https://search.ebscohost.com/login.aspx?direct=true&db=eric&AN=EJ1194174&site=ehost-live&scope=site

Herzog, S. (2018). Financial aid and college persistence: Do student loans help or hurt? Research in Higher Education, 59(3), 273–301. Retrieved from https://search.ebscohost.com/login.aspx?direct=true&db=eric&AN=EJ1175110&site=ehost-live&scope=site

Menges, K. K., & Leonhard, C. (2016). Factors that affect willingness to borrow student loans among community college students. Journal of Student Financial Aid, 46(2). Retrieved from https://search.ebscohost.com/login.aspx?direct=true&db=eric&AN=EJ1109174&site=ehost-live&scope=site

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