The real student loan crisis
A month has passed since Congress allowed interest rates on federal student loans to double for some borrowers, increasing the cost of their college educations by as much as $4,500. While the debate continues to focus on the interest rate for future borrowers, it is ignoring the larger problem with student debt: the more than $1 trillion that had already been borrowed before the interest rate debate. This existing debt will continue to drag down borrowers’ financial security, which in turn drags down the entire economy. By how much? Demos, the public policy group where I work, has just released a study that estimates the economic impact of the existing student debt burden, and finds that it may cost the country more than $4 trillion in lost economic activity.
This economic drag happens because student loan payments take a significant bite out of many borrowers’ incomes, causing them to delay or forego important purchases or investments. A recent study by the American Institute of CPAs found that 75 percent of student debtors had made personal or financial sacrifices because of their student loan payments. Forty-one percent have postponed contributions to retirement plans, 40 percent have delayed car purchases, and 29 percent have put off buying a house. The effects of delaying making these crucial investments early in borrowers’ lives, in turn, are magnified because of the amount that the lost home equity and investment returns would have compounded over their entire working lifetimes.
Our study tries to estimate just how much delaying saving for retirement or purchasing a home will cost borrowers over their lifetimes. We use data from the Federal Reserve’s 2010 Survey of Consumer Finances (SCF) to determine the average salary, retirement savings, and liquid savings of an average, young, dual-headed, college-educated household both with and without education debt. We then project their salary and assets over a lifetime using generally-accepted values for salary growth, savings rates, investment returns, etc. We reduce the savings of the indebted household by their monthly student loan payment while they are repaying their loan, and observe the difference in net worth between the debt-free and indebted households as they approach retirement.
The model finds that a dual-headed, college educated household that graduates with an average amount of debt ($53,000) will lose more than $200,000 in retirement savings and home equity from paying off their student loans, compared to a similarly educated household without student debt. Nearly two-thirds of this lost wealth is due to the indebted household’s lower retirement savings while paying off their student loans, while more than a third is from lower home equity. (Our model does not factor in any reduction in spending that the couple makes aside from what they spend on a home and retirement savings.) The lower home equity was primarily due to the finding, calculated from the SCF data, that indebted households bought less expensive houses than similar debt-free households. They also put less money down and paid a higher interest rate. These lost returns and appreciation on the foregone retirement savings and home equity are magnified because they occur so early in borrowers’ lives. And this is exactly why I argue that the existing student debt burden already weighing on nearly 40 million Americans is the greater crisis: because student debt causes borrowers to delay making investments at the very time when making those investments is so crucial to their future financial security.
The impact of student debt on financial security will be even greater on many borrowers, however, because our brief’s calculation of the wealth loss caused by student debt is, in many ways, a best-case scenario. The $200,000 estimate for lost wealth is for an average dual-income household where both partners graduated from four-year public universities and are never unemployed and always save thereafter, but the large number of graduates from less-ideal circumstances face even greater losses. As our brief highlights, students who graduated from private not-for-profit schools, students of color, and students from low-income families graduate with larger average debt burdens than the average public school graduate. Seventy-five percent of students from families with incomes less than $60,000 graduate with student loan debt, a higher share than the 66 percent of graduates overall who do. More students at private not-for-profit colleges graduate with debt, and more of it: as of 2008, an average of $27,650, about a third more than public school grads. But the hardest hit by student debt are for-profit college students. Not only do they graduate with the highest average debt ($33,050) but they’re also less likely, for various reasons, to find a job after school. The wealth loss from their student debt is so large that some for-profit graduates are effectively “underwater” on their college investment: they will actually have a lower lifetime net worth than if they hadn’t gone to school at all.
This “debt-for-diploma” system is clearly unsustainable, both for students and the country as a whole. The wealth losses caused by heavy student debt burdens are eating away at the income gains from a college degree, thus eroding the last secure pathway to the middle class in this country. And though student debt won’t cause an economic crash like mortgage debt — largely because of unfair laws that prevent discharging student debt in bankruptcy — its impact on the economy will still be catastrophic. If we spread out our estimated $4 trillion in lost economic activity from student debt over ten years, we can predict that student debt may directly reduce GDP growth by as much as 2 percent per year, not even accounting for student debt’s indirect effects on the economy. And let’s not forget about the millions of borrowers at risk of defaulting on their student loans. Thirty-five percent of borrowers under 30 currently repaying their loans are more than 90 days late on their payments; many will default, and thus have their credit ruined and be unable to buy a house, among other consequences. So, after Congress fixes student loan interest rates, it shouldn’t stop there. It needs to enact larger legislation that will give relief to borrowers already weighed down by debt, or the entire country will pay the price.
PHOTO: Graduating students arrive for Commencement Exercises at Boston College in Boston, Massachusetts May 20, 2013. REUTERS/Brian Snyder | CHART: Courtesy of Demos