Financial Literacy and Student Debt

Abstract

Using a large sample of over 1,000 students from a major, land-grant, public university in Massachusetts, we examine the financial literacy level of college students, and its implications on the repayment of student debt. We find low levels of financial literacy (39.5%), particularly among female (26%), minority (24%) and first-generation (33%) students. Based on survey responses, we show that students with a deficit in financial literacy are more likely to underestimate future student loan payments; 38.2% of low-literacy students underestimate future payments by more than $1,000 annually, while high financial literacy reduces the probability of significant payment underestimation by 17-18 percentage points. Furthermore, we find evidence of a financial literacy wage gap as students with low financial literacy expect significantly lower starting salaries than their high-literacy peers. As a result, low-literacy students are more vulnerable to unexpected, adverse shocks on their payment-to-income ratios that can impair their future creditworthiness and undermine their ability to service debt post-graduation.

Keywords: financial literacy, student debt, literacy wage gap, student loan default

JEL Classification: D84, I22, I23, J16