America’s student loan debt crisis is about to get much worse

The next generation of graduates will include more borrowers who may never be able to repay

By Riley Griffin, Suborna Panja & Kristina D’Alessio / BLOOMBERG

While Wall Street and US President Donald Trump tout news of a booming stock market and low unemployment, college students may be quick to roll their eyes. The improved economy has yet to mean higher wages for graduates already struggling to pay down massive debt, let alone ease the minds of students staring down the barrel of six-digit loan obligations yet to come.

Federal student loans are the only consumer debt segment with continuous cumulative growth since the Great Recession.

As the cost of tuition and borrowing continue to rise, the result is a widening default crisis that even US Federal Reserve (Fed) chairman Jerome Powell labelled as a cause for concern.

Student loans have seen almost 157% in cumulative growth over the last 11 years. By comparison, auto loan debt has grown 52% while mortgage and credit card debt actually fell by about 1%, according to a Bloomberg Global Data analysis of federal loans. All told, there’s a whopping US$1.4 trillion (RM5.82 trillion) in federal student loans out there, marking the second-largest household debt segment in the country, after mortgages. And the number keeps growing.

Unprecedented Rates
Student loans are being issued at unprecedented rates as more American students pursue higher education. But the cost of tuition at both private and public institutions is touching all-time highs and interest rates on student loans are rising. Students are spending more time working instead of studying. Experts and analysts worry that the next generation of graduates could default on their loans at even higher rates than in the immediate wake of the financial crisis.

“Students aren’t only facing increasing costs of college tuition; they’re facing increasing costs of borrowing to afford that degree,” said John Hupalo, founder and CEO of Invite Education, an education financial planner. “That double whammy doesn’t bode well for students paying off loans.”

Federal student loan debt currently has the highest 90+ day delinquency rate of all household debt. More than one in 10 borrowers is at least 90 days delinquent, while mortgages and auto-loans have a 1.1% and 4% delinquency rate respectively, according to Bloomberg Global Data. While mortgages and auto-loans have seen an overall decrease in delinquencies since 2010, student loan delinquency rates remain within a percentage point of their all-time high in 2012.

High Defaults
Delinquencies escalated in the wake of the Great Recession as for-profit colleges pitched themselves as an end-run around low-paying jobs, explained Judith Scott-Clayton, a Columbia University associate professor of economics and education. But many of those degrees ultimately proved useless, leaving graduates with debt they couldn’t pay back.

Students attending for-profit universities and community colleges represented almost half of all borrowers leaving school and beginning to repay loans in 2011. They also accounted for 70% of all defaults. As a result, delinquencies skyrocketed in the 2011-2012 academic year, reaching 11.73%.

Today, the student loan delinquency rate remains almost as high, which Scott-Clayton attributes to social and institutional factors rather than average debt levels. “Delinquency is at crisis levels for borrowers, particularly for borrowers of colour, borrowers who have gone to a for-profit and borrowers who didn’t ultimately obtain a degree,” she said, highlighting that each cohort is more likely to miss repayments on their loans than other public and private college students.

Those most at risk of delinquency tend to be, counter-intuitively, those who’ve incurred smaller amounts of debt, explained Kali McFadden, senior research analyst at LendingTree. Graduates who leave school with six-figure degrees that are valued in the marketplace — like post-graduate law or medical degrees — usually see a good return on their investment.

Hupalo agreed. “There’s a systemic problem in the student loan market that doesn’t exist in the other asset classes,” he said. “Students need to get a job that allows them to pay off their debt. The delinquency rate will rise as long as students aren’t graduating with degrees that pay back that cost.” Moreover, while college dropouts and for-profit graduates often struggle to find jobs with high enough wages to pay for their education, minority graduates are more likely to face discrimination in labour markets, making matters worse.

Rising Borrowing Costs
The cost of borrowing has also risen over the last two years. Undergraduates saw interest on direct subsidised and unsubsidised loans jump to 5% this year — the highest rate since 2009 — while students seeking graduate and professional degrees now face a 6.6% interest rate, according to the US Department of Education. (The federal government pays off interest on direct subsidised loans, while a borrower remains a student or if they defer loans upon graduation, but doesn’t cover interest payments on un-subsidised loans).

“If you’re in an interest-based plan, you see cost go up, which worries me for students who are in school and have seen debt go up before they’ve even finished,” Scott-Clayton said. She said borrowers with smaller amounts of debt, those most at risk of default, should take advantage of income-based repayment plans if they can.

Impact on Economy
The deepening student debt crisis isn’t just bad news for students and recent graduates. The delinquencies that come with it may have a significant negative impact on the broader economy, the Fed chairman told Congress earlier this year.

“You do stand to see longer-term negative effects on people who can’t pay off their student loans. It hurts their credit rating, it impacts the entire half of their economic life,” Powell testified before the Senate Banking Committee in March. “As this goes on and as student loans continue to grow and become larger and larger, then it absolutely could hold back growth.”

As young adults struggle to pay back their loans, they’re forced to make financial concessions that create a drag on the economy. Student debt has delayed household formation and led to a decline in home-ownership.

Sixteen percent of young workers age 25 to 35 lived with their parents in 2017, up 4% from 10 years prior, shows Bloomberg Intelligence.

“You have a whole generation of people that have a significant amount of student loans and its crimping demand for other goods and services,” said Ira Jersey, the chief US interest rate strategist for Bloomberg Intelligence. “As people live with their parents or cohabit with a non-partner, millions of houses and apartments aren’t being purchased. Neither is WiFi or that extra sofa. We think this is having a significant impact on the economy.”

Still, Jersey doesn’t think the student debt crisis is as severe as the subprime collapse of a decade ago. “It’s much different than mortgages,” Jersey said. “Even though it’s a crisis in that it increases the deficit, and taxpayers have to pay more over time, it doesn’t present a systemic financial sector risk like mortgages in 2007.”

However, that doesn’t offer much consolation to students, six in 10 of whom report frequent anxiety about their debt, according to a report from Chegg, an education technology company. To quell fears of delinquency, Scott-Clayton said students should be proactive in researching different repayment plans.

“You have to wonder if the lack of transparency surrounding (student) loans is intentional,” she said. “Students shouldn’t assume their loan servicer has their best interest in mind.”