Closing the Financial Literacy Gap to Combat Student Debt

Experts say knowing the dangers of over-borrowing and how to repay loans can help tackle student debt.

Experts say teaching students about what their repayment options are before they take out loans can help reduce debt.
By + More

Politicians, academics and students alike have all criticized the ballooning cost of college and its contribution to the existing mountain of outstanding student loan debt. But students also suffer from a lack of financial literacy that leaves them unable to navigate the complex maze of financial aid applications and loan options, further adding to their money troubles even after they leave school.

National student loan debt now tops $1.1 trillion, with the average student accruing more than $26,000 in debt upon graduating. And more than half of this outstanding debt is not being repaid because borrowers are struggling financially. Many have said these statistics are the result of a higher education system that has become increasingly inaccessible and unaffordable. But it also stems from a deeper issue: students don't know what they're getting into when they take out loans, and they don't know what their options are when they have to pay them back.

[READ: Which Student Loan Repayment Plan Should You Choose?]

"It comes back to a financial literacy issue and making sure students understand what they're getting into, how much they're borrowing and understanding there are different options for them at the end," says Megan McClean, director of policy and federal relations at the National Association of Student Financial Aid Administrators.

In his Aug. 22 speech announcing a plan to tie federal financial aid to colleges' performance, President Barack Obama also made a proposal to tackle one aspect of student debt that can start immediately, without congressional approval: he pledged that the Department of Education will reach out to struggling borrowers by encouraging them to enroll in income-based repayment plans. Of the millions of federal loan borrowers currently in repayment, roughly 10 percent are enrolled in one of these plans, according to the Consumer Financial Protection Bureau.

"Those programs really are under-utilized when you consider how many students we have going into default," McClean says.

[ALSO: What to Consider Before Consolidating Your Student Loans]

But when students aren't aware of or are confused by different repayment options, those who are struggling financially sometimes just stop paying. After nine months of doing so, they default on their loans, which can affect credit scores, lead to wage garnishments, and if left unresolved for long enough, can even take a bite out of the their Social Security checks, according to Lauren Asher, president of the Institute for College Access and Success.

The Department of Education on Monday released new data that show the number borrowers who default on their student loans within two years of entering repayment has increased for the sixth year in a row. The Consumer Financial Protection Bureau estimates there are more than 7 million borrowers in default on a federal or private student loan.

"It's crucial that borrowers are getting good and timely information about repayment options before they fall so far behind that they default. They need to know that these plans exist," Asher says. "The default rates that just came out are just the tip of the iceberg."

[MORE: Student Loan Default Rates Rise for Sixth Year]

Those numbers, which monitor students who default within two and three years of entering repayment, don't include delinquencies, which occur when borrowers fail to make payments for more than 90 days. They also don't reflect the number of borrowers who are struggling to make payments, or borrowers who default after being in repayment for more than three years.

Asher says borrowers often default because they are not aware of more flexible repayment options that adjust payments based on the borrower's income. But what many borrowers also don't know is that once they default on their loans, they are no longer eligible to enroll in these programs.

That's why many say this type of financial education should start much earlier, before students get to college. In fact, several states – including Tennessee, Virginia, Missouri and Utah – have mandated that financial education be included in K-12 curriculum. But according to a 2011 survey from the Council for Economic Education, less than 20 percent of teachers feel competent in teaching personal finance topics.