Mess of Education Loans

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Education Loans

There has been an increase in the defaults on education loans. Private players were always reluctant to provide education loans and the burden was mainly on government institutions. Now the government institution also seems to give up. This is despite the fact that education loans have higher interest rates than other loans. Under such circumstances, seekers of higher education are in distress.

Education loans defaults

As per the CNBC, more than 3000 students default on their education loans every day in the US. There is 17 percent increase in federal student loans default from 2015 to 2016. In 2016, 4.2 Million borrowers were in default up from 3.6 million in 2016. As default period in the US is 270 days, no payment is made in these default accounts for more than 270 days. This is despite the rise in stock market & falling Unemployment levels. The situation is similar across other nations also – in Europe & developing nations. In India, there has been 142 percent rise in default loan over past few years. As per RBI, at the end of December 2016, loans worth of Rs 6336 crore was at default against Rs 2615 crore in March 2013.

Overall, NPAs in the education loans are rising at a faster rate. This has led the private investors, banks to keep a distance from education loans. There were already few institutions to provide education loans. This has further worsened the situation of under investment in human capital.

Investment in human capital vs. Physical capital

To understand the reasons behind all this we need to understand at first – why education loans are different from other loans?

Education loans are an investment made in human capital & thereby is different than other forms of investment. Education loans for professional courses, vocational training increases the future earnings of the concern individuals. The returns to a lender on investments in human capital i.e. education loan depend on the future earning capacity of the individual. Therefore, return to a lender on education loans depends on the increase in productivity & future market value of this gained productivity by individuals after attaining the course.

An investment in human capital will be made by either individual or a lender only if – the return is comparable to any other physical investment including the opportunity cost forgone. Opportunity cost includes the possible earning for the duration of the course along with the return on investment if made somewhere else. For example – if a person is going for post-graduation which has two years of duration. Then the overall return after doing post-graduation should be higher or equivalent to the earnings forgone in the two years & the return on the amount of expenditure during MBA at market rate.

Limited lenders to education loans

Security & Risk Concern

A physical loan has an associated security in the form of asset, which can be sold to recover a part of the payment. An education loan doesn’t have any such comparable security. Some banks insist to attach a physical asset to education loans to cover this. Therefore a person who doesn’t have any security to offer is less attractive to get an education loan.  The second risk comes from the default on payment. There are many reasons like Death, a difference in ability, energy, and good fortune for an individual to default on a loan. Because of this, there is huge variation around average. This leads to the higher interest rate charged on all loans to balance the loss on defaulted accounts.

Education loans generally have long durations. Also, the individuals often change cities, countries in search of work. They regularly change their organizations. All these reasons increase the risk of losing track on individuals & increase the cost of chasing them.

Supply & Demand Risk

Education loans are given on the assumption of future earnings. Future earnings are not certain and tend to vary as per market structure. Since professional courses duration varies from one year to even five or six years, long periods give rise to uncertainty.

An individual will gain skills after a professional course, which will render him with higher wages. If too much (more than demand) individuals choose that professional course, there will be excess of them in the market. In such a case there will be a fall in wages or even unemployment. This will lead to a default on loans. This is what has happened in the case of education loans disbursed to engineering education in the southern Indian States.  Another possibility is the reverse of the previous case – fall in the demand of the individuals from a specific professional course.

We see that the reasons for having limited lenders into education loans are also the reasons for rising in defaults.

Double edged Sword

The increase in education loans doesn’t create a problem of recovery of investment only, it is also a burden on students also. It becomes almost impossible for such students to build their future from here. This will also detract students from seeking higher education or professional courses. There are two major problems in front of states – recovery of the investments made & to maintain the student’s interest in higher education.

Under such circumstances, it becomes important to review the system of higher & professional education. There are many questions which arise here – Does the high cost of higher education is justified? Is there any substitute for education loans? What are the options available for default borrowers and also for lenders?

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