The Senate Judiciary Committee’s Subcommittee on Administrative Oversight and the Courts today will host a hearing on “the looming student debt crisis.” Although newspaper articles and blog posts have highlighted ascending student debt and the burden that student loans leave on college graduates, there is still a question as to whether rising student debt is, in fact, a crisis that warrants congressional action.
We think it is. Rising student loan debt has serious implications for both individual consumers and the overall economy. Here are five key reasons why educational debt should be a national priority and not just an issue for student advocates.
1. The usual statistics don’t tell the whole story on who has debt—and who’s struggling to pay it
Certain numbers are often quoted to show the extent of student loan debt, including the average debt for those who borrow to complete a bachelor’s degree (around $24,000) and the average default rate on student loans (8.8 percent). These numbers indicate that student debt could be a problem, but they do not express the full extent of educational indebtedness or the difficulty individuals have paying these loans.
For one thing the average debt for those who complete a bachelor’s degree leaves out all of the students who took on educational debt but did not finish a degree. This is a particularly important group at for-profit institutions, given that more than half of students at some for-profit colleges leave without a degree, and more than 90 percent of students at those same schools take on student loans.
Sure, these students probably took on less debt than their classmates who graduated. But they did not get the income benefit of a degree, so they may have more trouble paying back debt than college graduates. In fact, a study by the education think tank Education Sector shows that borrowers who drop out of college are four times more likely to default on their loans than those who finish.
The usual statistics on student loan default also obscure the extent to which borrowers struggle to repay by focusing on default rather than delinquency. To be considered in default, a borrower must fail to pay a student loan for nine months. The rate of default does not account for those who miss payments on their loans for any period of time less than nine months.
The Federal Reserve Bank of New York recently posted a study that sheds some new light on the extent of student loan debt in the United States. Its analysis of Equifax credit reports shows $870 billion in outstanding student loans. It also revealed a concentration of debt among young people: 40.1 percent of individuals under age 30 have outstanding student loan debt—compared to 25 percent of people ages 30–39—with an average debt load of $23,300.
But perhaps the most important contribution this study makes is clarifying just how much borrowers struggle to repay their debts. The Federal Reserve estimates that around 27 percent of borrowers have past-due balances on their loans, suggesting that the federal student loan default rate reflects only a fraction of the borrowers who are late in their payments.
2. Debt holds graduates back—and that holds the economy back, too
It’s obvious that past-due payments on loans holds borrowers back—those unfortunate enough to default on federal student loans will find their credit ratings suffering, their wages garnished, and their tax refunds or other federal benefits used to offset loan debt. But having outstanding student debt has a negative effect even on those who are making steady payments. The money graduates put toward their loans is money they cannot use to make other purchases, like a home or a car. It’s also money that can’t be put into savings.
These foregone purchases are not just individual misfortunes—they can hold back macroeconomic growth. First-time homebuyers are essential to the rebound of the housing market. But according to the Federal Reserve, fewer young people are getting mortgages—just 9 percent of 29- to 34-year-olds got a first-time mortgage from 2009 to 2011, compared to 17 percent in 2001.
At a time when economists are closely watching consumer spending and hoping for growth, it is important to recognize the fact that the trend in student borrowing may be working against our economic interests.
3. Massive student loan default could spell disaster
If you think outstanding student loan debt is bad for the economy, imagine what massive student loan default would do. Federally backed loans account for almost $700 billion of the outstanding student loan debt, so any significant increase in student loan defaults would be a blow to federal balance sheets.
And though total outstanding credit card debt is almost as high as student loans, that debt is held by a larger group of people—the Federal Reserve found that the $870 billion in student loan debt was spread among 15 percent of consumers, whereas the $693 billion in credit card debt is held by nearly 80 percent of Americans. In other words, the financial missteps of a relatively small number of Americans could be enough to cause problems in the student loan market.
The default rate on federal student loans is higher than it has been in a full decade, and as the total outstanding loan balance grows it is important to consider the consequences of increased default. Still, the comparisons to the housing market, or the suggestion that there is a student loan “bubble,” are likely blown out of proportion, as student loan debt is far smaller than outstanding mortgage debt.
4. Debt is getting more expensive for students
The status of outstanding student loan debt should be enough to convince policymakers that they must consider changes to the student loan program. But the problem of student debt will further compound if low-interest federal loans are eliminated. Current legislation would end one low-interest loan program and hike the interest rate on another, making student loans much more expensive for low-income students.
There are currently three main federal loan options available to students, each with a different interest rate. Subsidized Stafford loans have an interest rate of 3.4 percent for undergraduates, and the federal government subsidizes this interest while the student is in school. Unsubsidized Stafford loans carry an interest rate of 6.8 percent. And the federal Perkins loan program has a subsidized interest rate of 5 percent.
The relatively low interest rates on subsidized Stafford loans and Perkins loans help students keep their debt in check and make it easier to pay down the principal of the loan. But both of these programs are set for change unless Congress takes action. The interest rate on subsidized Stafford loans is set to double to 6.8 percent in July of this year. And the Perkins loan program will expire in 2014. Without these options, borrowing for education will become much more expensive for students with financial need.
5. Once in debt, students have few options for getting out
Borrowers who find themselves unable to pay their student loans have only a few options available to dig out of debt. Deferments and forbearances—programs that suspend monthly loan payments—provide short-term debt relief, but interest on the loans may accrue and capitalize during the forbearance or deferment period, making the loans more expensive in the long term. Income-based repayment, an option that reduces monthly loan payments to a percentage of discretionary income, provides a better long-term solution for borrowers who cannot afford the standard repayment rates on their loans. But the low take-up on this program suggests that either students are unaware of the program or it is not providing the solution borrowers desire.
And to the extent that there are debt-relief programs available, they are limited to federal student loans. Students with private loans cannot use income-based repayment to limit their payments; they can’t even discharge these loans in bankruptcy.
With high unemployment and underemployment and so few options for dealing with debt, it should come as no surprise that the delinquency rate on student loans is so high. If Congress wants to find an answer to default and delinquency, it should look no further than its own policies on discharging loans in bankruptcy and providing short-term debt relief for struggling borrowers.
How Congress can respond
A typical response to the problems inherent in the student loan system is to suggest limiting access to educational debt. But student loans have been essential to increasing college access and affordability. Rather than get rid of loans, Congress must take action to ensure that student loans are a tool to help students make it into the middle class, rather than an anchor that drags them further into poverty. Here are some steps Congress can take now to improve the student loan system:
- Ensure that the lowest-income students have access to grant aid by maintaining investment in the Pell Grant, a program that provides grants of up to $5,550 to qualified students.
- Maintain low-cost student loans by extending the Perkins loan program and stopping the scheduled increase in the Stafford loan interest rate.
- Provide sensible debt relief that fits the needs of young college graduates by improving the application process and terms of the income-based repayment program and allowing borrowers to discharge private student loans in bankruptcy.
- Provide better quality and value for students by cutting off poor-performing colleges’ access to student loan programs.
Julie Margetta Morgan is the Associate Director of Postsecondary Education at American Progress.