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Karsten: Will Student Debt Lead to a Financial Crisis?

Protesting the projected $1 trillion in student loan debt, Occupy Student Debt Campaign (OSDC) is organizing a proactive march on Wall Street April 25th to honor National Day of Action Against Student Debt. According to the Federal Reserve Bank of New York, the average student loan balance per borrower is $23,300; paying for college now outpaces the national rate of credit card commitments.

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It is not just college education that is driving Americans into debt. In an effort to give their children a competitive edge, parents paying $10,000 to $30,000 per year for private grade school and high school is becoming more prevalent. Private companies are available as consultants to help students score higher on standardized tests and make their applications more attractive to the higher profile schools in hopes of garnering more scholarship dollars.

The recent recession also motivated thousands of Americans to return to the classroom – and according to the New York Federal Reserve - citizens over the age of 60 to collectively amass nearly $36 billion in tuition debts. Taxpayers, however, bear the largest brunt because the federal government guarantees 8 in 10 student loans.

This is significant considering –according to Fitch Ratings Agency - nearly a third of borrowers are at least 30 days behind on paying their notes. A debt payment obligation that begins six months after graduation, federal student loans cannot be forgiven in bankruptcy court. After nine months of delinquency, the government can garnish wages, seize tax refunds and sequester Social Security benefits. This is in addition to assessing stiff penalties and collection fees, adding to the balance owed.

A Brockhouse & Cooper, Inc. report indicates since 2001, college tuition has skyrocketed 57 percent. Meanwhile, the average weekly wages of recent college graduates, ages 25 to 34, fell 7 percent. As a result, the postsecondary education bill is becoming a heated bipartisan issue. The White House is launching an aggressive campaign to encourage Congress to extend the 2007 College Cost Reduction and Access Act. This mandate lowered the Stafford interest rate to 3.4 percent. If Congress fails to act, the rate will double on July 1, costing students an estimated $6 billion more.

"The quest to provide a better life for their children can create a lager financial mess for the parents." -Pres., CIO Karsten Advisors, Tom Karsten

Scholarships are the best way to pay for college but competition is fierce and the research and application process is arduous. Students also pay for education credits with work study programs that enable them to earn money while learning valuable business skills. Unlike state-run colleges, private institutions are able to dip into university endowments to sponsor merit and need-based scholarships that subsidize tuition costs. With a portfolio reaching $31.7 billion, Harvard holds the largest educational endowment in the world, according to the NACUBO-Commonfund Study of Endowments. Yale comes in a distant second with $19.3 billion.

Parents and students have an array of options for financing education costs, including private loans from banks, tapping home equity credit lines and dipping into retirement accounts. However, the quest to provide a better life for their children can create a lager financial mess for the parents.

The College Debt Crisis - See Complete Coverage
The College Debt Crisis - See Complete Coverage

The better alternative is secure the lower-interest, government-backed Perkins or Stafford loans, which are not dependent on family income. The biggest mistake parents make is not filing the FASFA form because they believe their income is too high. An estimated 2 million students who would have qualified forfeited federal assistance last year simply because they did not apply.

Since going into effect, 529 college saving plans have become an attractive route to attending college. There is wide divergence in how these plans are set up and money is distributed, but accounts either are managed similar to a 401(k) plan or consist of prepaid credits that lock in the current tuition rate.

Regardless of how the economy is performing, an education cannot be taken away, and it does not lose its value. While the government considers ways to extend the current tax credit, students must effectively manage their college careers by choosing the right field of study if they hope to see a return on investment.

Tune In:

Watch CNBC all day Tuesday, April 24th for “The Price of Admission” special reports about the impact of higher college costs on the economy.

Tom Karsten is President and Chief Investment Officer of Karsten Advisors, an SEC Registered Investment Advisor in Fort Worth, Texas. Tom Karsten received his Bachelor of Science degree from The University of Houston and his Master’s degree from Texas Christian University.

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