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Apr 28, 2021 Student loan debt and the continually increasing cost of getting a college education received some heated debate during the most recent presidential election. Parents and business leaders alike have wanted action taken on these issues for many years. Some leading economists have also voiced their concerns, since the Great Recession of 2009, that student loans could be the next financial bubble to burst and start the next American economic downturn. With all that said, we ask: is there a student loan debt bubble and how will it impact the financial markets?
Student Loan Debt Statistics
It’s important to understand how much student loan debt there currently is in the United States. Student loan debt is the second-highest type of personal debt at $1.3 trillion. The average 2016 college graduate owes $28,000 in student loans and that total number is projected to increase for the class of 2017 and all other graduating classes in the foreseeable future. Before 2009, student loan debt was the 4th most common type of personal debt, but it surpassed credit card and auto loan debt during the years 2010 and 2011, respectively. There are two leading reasons for this sharp increase.
The first reason is many millennials have remained in school longer by pursuing a Master’s degree immediately after earning their Bachelor’s degree, before entering the workforce. Secondly, college tuition increases have been quickly rising and institutions have also received less government aid per student since 1980.
State governments previously funded approximately 75% of a public college’s budget, however, that figure has now dropped to 25%.
What About Student Loan Default Rates?
If the student loan bubble was going to burst, default rates would skyrocket, right? The most recent statistics released by the U.S. Department of Education, the leading originator of most student loans, show that federal student loan default rates have decreased in the years following the Great Recession. The most recent data tracks federal loans that entered repayment status on October 1st, 2015 and considers a loan in default status when it is at least 9 months behind schedule in payments. Compared to loans that entered repayment status the year before, the total default rate dropped slightly from 11.8% to 11.3%. This rate is still notably higher than pre-Great Recession student loan default rates that ranged from near 6% in 2003 to 8% in 2008.
While a decreasing default rate is encouraging news, there are some concerns that economists share. For starters, enrollment in federal income-driven repayment plans has skyrocketed 140% from 2013 to 2016 with at least 4.6 million borrowers currently enrolled. These plans extend the repayment plans from the standard 10-year term to 20 or 25-years and cap the monthly payments at 10% of the borrower’s income. While graduates are making smaller monthly payments, they end up paying more in interest charges because it can take an additional decade to repay the loans. This can delay other large purchases like buying a house or upgrading vehicles as a result.
Are Student Loans the Next Housing Bubble?
There is a right to be concerned about the long-term financial impact of student loans. College costs have been increasing each year for nearly four decades and it is astounding that it moved from the fourth largest form of personal debt to the second most common form largely because of the Great Recession. While parents had to curtail spending and borrowing because of the mortgage crisis and large drops in home values, young adults continued to attend college and enrollment increased. As more students competed for less financial aid resources, the only option for many families was to borrow more to afford college.
>> Read More: Citi draws frightening parallel between student loans and mortgage crisis
Similar to the 2008 housing crisis, families continued to borrow more to buy a house because they needed a place to live. Eventually, the high home prices caused monthly mortgage payments to be too much for those that bought in the final years of the housing boom. While today’s college graduates might be able to afford the monthly payments, the rapid increase in income-based repayment plans cannot continue indefinitely. Delinquency and default rates might increase as salaries remain relatively stagnant despite more student borrowing. It might be too early to tell if the student loan bubble is indeed the next housing bubble, but if some of these trends continue, we might find out in the near future.