The student loan debt crisis has gripped the United States, sending legislators, government agencies and finance experts scrambling for appropriate solutions to address the problem that has become both a financial and political issue.
As of the second quarter of 2019, the overall student loan debt of over 44 million Americans stood at $1.48 trillion, slightly down from $1.49 trillion in the preceding quarter. Student loan debt is now the second-highest consumer debt category, trailing behind mortgage loans, and edging out credit card debt and auto loans.
Student loan defaults
Statistics reveal that over 1 million borrowers fail to pay their student debt annually. Almost 40 percent of them are projected to default on their student loans by 2023, according to a 2018 study from the Brookings Institute.
The same study revealed that default rates and debt loads for black college students have reached “crisis levels,” including those who graduated with a bachelor’s degree. Black graduates with a bachelor’s degree are more likely than white college dropouts with student loans to not pay their debts. The report added that about 50 percent of students in for-profit higher education institutions default within 12 years of joining the schools, added the report.
Meanwhile, a new report from the New York Fed found that the number of student loan defaulters has increased rapidly in the second quarter of 2019, with 35 percent of defaulted student loans accounting for about $250 billion of the “severely derogatory” consumer debt outstanding balance, which makes up nearly half of all delinquencies.
According to the New York Fed, “severely derogatory” refers to “any stage of delinquency paired with repossession, foreclosure, or ‘charge of,’” which means the lender has scratched off the debt from its books. The report pointed out that defaulted student loans have “grown stunningly since 2012.”
Factors that led to a rise in loan defaults
While the idea of a college degree to secure a better future drives many Americans to obtain student loans, it turns out that their future may not be so bright after all. Studies claim that not everyone with a debt burden gets a degree, and only a few have the ability to repay their student loans, whether they have a degree or not.
The rise in student loan default rates can be attributed to the ever-increasing tuition fees and stagnant wages. Other factors that contribute to the rise in defaults include the increasing number of non-traditional students – those who go back to college in the hope of finding a new career, and those who enrolled in for-profit schools, which are owned and run by private firms with investors and shareholders, and which generally offer online courses targeted at non-traditional students.
Student loan debt and the economy
As a result, student debt has become a “life sentence” for millions of Americans, with many postponing significant life milestones such as getting married, having children, buying a property or a car, and saving for retirement.
A June 2019 study by Demos found that individuals who begin college after the age of 20 or those who enroll to go back to college following a break find it difficult to pay off loans. Twelve years after leaving higher education, the average borrower who started college after the age of 20 will have paid off only five percent of their student loans. Therefore, financial insecurity compels many Americans to delay marriage or the decision to have children.
On the other hand, a 2018 study by Summer and Student Debt Crisis showed that 56 percent of respondents could not buy a home due to their education debt, while 58 percent had a lower credit score due to student loans. A low credit score shuts the doors for individuals who want to own a property or a car or set up a business.
The debt burden has also hindered some borrowers from saving for their retirement. About 84 percent of borrowers said student loans have eaten up their retirement savings, with those having higher student loan debt likely to have less saved for retirement, according to a recent report.
Student loan bubble
The question now is: is there a student loan bubble?
A bubble is a cycle in the economy when assets see a rapid rise in prices, followed by an abrupt and significant fall in prices. Bubbles take place when investors start to purchase assets without giving much consideration to their economic value for the purpose of selling these to the next investors at excessively high prices.
Once the ball starts rolling, investors want more, inflating the prices beyond what the assets are actually worth. Eventually, when investors are no longer interested in the over-inflated assets, a massive sell-off begins, resulting in a sudden drop in prices as supply exceeds demand, which is when the bubble bursts.
One example of a bubble was the mortgage crisis prior to the 2008 global financial crisis.
It saw people with low credit scores and debt problems being granted subprime mortgage loans. With low-interest rates on mortgages, house purchases rose among subprime borrowers and rich Americans, leading to the rapid rise in housing prices and the high number of subprime lending products on the market.
When the situation created worries of a bubble, the Federal Reserve raised the interest rate several times to correct the market. With rising interest rates, homeowners defaulted on their loans and the real estate market collapsed.
The subprime mortgage crisis resulted in a tremendous drop in property prices, forcing banks to foreclose on homes as owners could no longer pay the high-interest rate while the value of their home fell. The crisis also impacted investors, investment banks and other lenders, leading to the Great Recession.
Student loan debt crisis vs. the mortgage crisis
Analysts argue that the existing student loan debt crisis bears similarities to what occurred in the mortgage market before the global financial crisis.
Both are “bubbles” in that statistics on debt and defaults on both crises reached alarming levels. The current rate at which student loan borrowers fail to pay their debt is close to the rate at which homebuyers missed their mortgage payments during the 2008 financial crisis.
Data showed that borrowers delayed the payment of about 9.9 percent of student loan balances for at least 90 days in the second quarter of 2019, compared with 9.4 percent in the first quarter. During the subprime mortgage crisis, delinquency rates hit a record high of 11.5 percent in 2010.
The student loan debt crisis also draws parallels to the 2008 financial crisis in that the total US consumer debt in the second quarter of this year hit $13.86 trillion, the 20th consecutive quarter with an increase, according to the New York Fed. The figure is $1.2 trillion higher, in nominal terms, than the previous record of $12.68 trillion in the third quarter of 2008, the New York Fed data showed.
Furthermore, cost escalation, which is typically met with resistance by consumers, is being countered with easy credit, similar to the mortgage market situation in 2008, an expert said. In this case, the rising cost of college tuition has driven the demand for student loans, much like 2008’s high property prices fueling demand for mortgage loans.
“Predatory institutions” also zero in on the same low-income segment that the mortgage boom zeroed in on by offering a similar promise of homeownership and a college degree as part of the American middle class dream, according to an education scholar.
These predatory colleges are for-profit schools that harness the power of online advertising to attract students, particularly non-traditional students older than 25 years of age.
A 2019 study by Century Foundation found that for-profit colleges top the list of higher education’s largest spenders in online search advertising. Offering two-or four-year degrees or professional certificates in fields such as culinary arts and health administration, among others, these schools appeal to those who belong to the lower-income segment, mostly women and single parents of Hispanic or African American origins. For-profit schools also lure many students as their fully online degree courses, and weekend and night classes fit around the schedules of those who have families or full-time jobs.
For-profit institutions reportedly engage in the practice of imposing unfair and deceptive loan terms on borrowers. Reports said they access federal student aid, burden their students with debt and leave them with a low-quality education, poor credentials, and non-existent career services.
Researchers said students who enrolled in these schools are often left unemployed, saddled with debt or with lower earnings.
For-profit colleges also make up about 10 percent of enrollment, about 20 to 25 percent of borrowing, and 50 percent of total loan defaults, leading researchers to conclude that for-profit certification gains cannot pay off a student’s average debt burden.
Borrowers’ distrust in lenders
Many student-borrowers have expressed disappointment and distrust in lenders and firms that facilitate federal loan programs. Some students accused the companies of misleading them and failing to provide them with the best repayment options.
One such firm is Navient, one of the biggest student loan providers and also the company with the highest number of student loan complaints.
Navient was sued by the American Federation of Teachers for allegedly misdirecting borrowers toward student loan repayment structures and types of forbearance that led them to pay millions of dollars more than what they are supposed to spend on student loan payments. The company was also sued in multiple states and by the Consumer Financial Protection Bureau for “failing borrowers at every stage of repayment.”
Will the student loan bubble burst?
While the mortgage crisis bubble exploded, experts believe the student loan debt crisis bubble won’t. During the mortgage crisis, lenders were able to repossess the homes of mortgage loan defaulters and sold them off, but they cannot do so with student loan defaulters whose loan collateral is their degree or future earnings. As such, the debt stays with the borrower until it is paid off.
Experts also believe that as the cost of higher education continues to rise, and a college or postgraduate degree continues to drive value in the workforce industry, a slowdown in education borrowing is unlikely to happen. Student debt and defaults are then expected to surge in the coming years.
However, several solutions have been proposed to manage the student loan debt crisis.
The Government Accountability Office (GAO) urged the US Congress to consider boosting schools’ accountability for student loan defaults. GAO stressed that schools and consultants must provide borrowers with accurate and complete information about loan repayment and postponement structures.
Other sectors suggested mandatory credit counseling for low-income borrowers and awareness campaigns on loan default options.
Some politicians also proposed free college education and payroll deduction of student loan payments.
Existing repayment plans
There are existing mechanisms in place aimed at easing borrowers’ debt as well.
Federal student loan repayment plans include income-driven repayment, which sets a monthly payment amount based on the borrower’s income; standard repayment, offering fixed payments for less than 10 years; graduated repayment, offering lower initial payments that rise every two years; extended repayment, payable for up to 25 years; revised pay as you earn repayment, featuring monthly payment at 10 percent of the borrower’s “discretionary” monthly income; pay as you earn repayment, which fixes the monthly payment at 10 percent of the borrower’s monthly “discretionary” income but not over the monthly payment made under the standard repayment; income-contingency repayment, which sets a monthly payment at the lesser of 20 percent of the “discretionary” income or what one pays under a repayment plan with a fixed payment within 12 years; and income-sensitive repayment, offered to low-income borrowers with Federal Family Education Loan Program loans.
In addition, student loan modification programs are offered by private lenders and state companies to address loan defaults.
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