June 12, 2018
Michael Taylor, CFA, Investment Strategy Analyst
Student Loan Debt Worries May Be Overstated
- Today, U.S. student loan debt stands at $1.4 trillion. This amount is roughly $850 billion greater than it was at the end of 2007.
- Total outstanding student loan debt has increased significantly in the past decade due to rising college costs, higher enrollment, and underutilization of college savings plans.
What It May Mean for Investors
- We believe that the current level of U.S. student loan debt does not pose a significant threat to financial markets. Yet, the outstanding debt load likely will remain a challenge for the economy and borrowers for the foreseeable future. This sizeable debt burden could impede future consumer spending and delay some younger consumers from making home purchases and forming households.
The outstanding balance of U.S. student loan debt is a concern for some investors. The long-standing and indelible economic and market effects of the mortgage crisis that occurred a decade ago are still fresh in the minds of many market participants. The heavy student loan burden, particularly that of Millennials, has made market watchers uneasy about this generation’s ability to manage debt and still contribute meaningfully to the housing-market recovery and consumer spending (the main driver of U.S. economic growth). In today’s report, we address concerns about student loan debt posing risks to the U.S. economy and financial markets. We examine the current state of student loan debt and discuss the implications for economic growth and future spending.
A current snapshot of U.S. student loan debt
The numbers are daunting. In the fourth quarter of 2007, U.S. student loan debt totaled $548 billion. Today, it stands at around $1.4 trillion.1 Currently, 37% of 18-29 year olds in the U.S. have outstanding student loan debt (Chart 1).2 In fact, nearly 45% of U.S. (Millennial) households under the age of 35 carry student loan debt with an average balance of $18,500.3 In contrast, fewer Gen Xers and Baby Boomers carry student loan balances today. However, average student loan balances for Gen Xers exceed those for both Millennials and Baby Boomers. According to Gallup, 25% of Gen Xers carry student loan balances of roughly $30,000.4 Similarly, the Pew Research Center found that 22% of those between the ages of 30 and 44 have outstanding student loan debt. Yet, the total amount of student loan debt outstanding for those under age 30 today (Millennials), stands at $383.8 billion. By comparison, in 2004, the total amount of student loan debt for those under 30 was $147.8 billion.5
Prior to the Great Recession, the delinquency rate on outstanding student loans was between 7% and 8%. Since then, it has increased—averaging about 11% today. Today, defaults on student loans remain greater than on other types of personal debt, including credit cards and auto loans. Defaults on credit cards and auto loans have eased back to below 8%. Not surprisingly, it appears that default rates for student loans are related to income and the ability to service the debt. Borrowers with debt loads below $5,000 have the highest default rates. Borrowers who attended for-profit schools and those who did not graduate also are at higher risk of default than other borrowers.6
Why is the amount of student loan debt rising?
Over the past decades, student loans have grown at a rapid pace—faster than that of credit card balances and auto loans. We see three reasons for this increase:
- College tuition rates are rising more rapidly than the rate of inflation. Since 2000, tuition rates have risen at a 5.4% annual rate versus 2.2% for inflation.7 At the time of graduation, student loan indebtedness averages approximately $28,700 today.8
- More students are attending college. In 2000, enrollment in undergraduate and graduate programs was 22 million. College enrollment peaked in 2010, reaching 29.5 million. This comes as no surprise. Historically, recessionary periods which offer limited job prospects have driven displaced and underqualified workers back to school. Since 2010, enrollment figures have eased somewhat, to 27 million today.9
- College savings plans are being underutilized. There was $324 billion in 529 college savings plans in the fourth quarter of 2017. This is a fraction of the $1.4 trillion in student loans that we see today.10
Does today’s student debt load pose risks to financial markets?
With $1.4 trillion in outstanding student loan debt, it is reasonable to ask if this could pose any risks to the economy or financial markets at some point. In our view, although servicing this amount of debt may pose some challenges to the U.S. economy, it does not pose the same level of systemic risk that we observed during the subprime mortgage crisis.
We see several reasons to support our view:
- The total amount of the outstanding student debt load in the U.S. is far less than that of mortgage debt. As Chart 3 shows, although the total amount of student loan debt now exceeds that of auto loans and credit card debt, it is far smaller than the amount mortgage debt outstanding. Even the sum of all the nonmortgage categories is only a fraction of the total mortgage debt.
- Student loan debt is largely government-held. Although delinquency rates for student loans are elevated, more than 85% of outstanding student debt is held by the U.S. government ($1.1 trillion). Only a small fraction of student loans are issued (and held) by banks and private lenders. In contrast, prior to the housing crisis, much of the mortgage debt was held by nongovernment lenders.
- Student loan debt is not dischargeable in bankruptcy. It is extremely difficult to discharge a student loan from one’s personal balance sheet. A likely scenario is that the debt is managed over a borrower’s working life.
- Flexible payments. Many student loan payments can be adjusted for a borrower’s income level and gradually increased over time. This helps to ease the burden of servicing the debt. As incomes rise over time, payments can increase. Adjustable payments have helped to ease debt servicing burdens for some Millennial households, offering a near-term benefit to consumer spending and economic growth. Yet, this could still weigh on future spending and asset purchases.
- Change in the composition of student aid. The composition of total financial aid for undergraduate students has changed over the past few decades. In 1996, grants comprised 50% of total student aid, while 49% were loans. By 2016, grants had increased to 55% of total aid, and loans had decreased to 36%. This divergence trend between grants and loans has been widening since 2009.11
Implications for the economy and investors
The current level of U.S. student debt does not appear to be as widespread as mortgage debt ahead of the financial crisis. Roughly 33% of the U.S. population has a college degree. And a college degree usually correlates with higher income and lower unemployment, when compared to workers with less educational attainment. Those with higher education levels tend to carry greater debt loads. Yet, workers with post-graduate degrees also tend to command higher salaries. In addition, some younger workers are taking on second jobs to help pay their student loan obligations.
Some market observers remain concerned that high burdens of student loan debt might discourage consumers from making large purchases, such as a car or a home. We acknowledge these concerns, but we believe that they likely are overstated. Research findings from the Pew Research Center and Gallup both show that U.S. adults who carry student loan debt are more likely to have an auto loan. This pattern is seen in Gen Xers and Baby Boomers as well. Furthermore workers with bachelor’s degrees (with or without student debt) are buying homes by age 30 at a percentage that is higher than that of those without a college education are (as shown in the table).
Looking ahead, a robust U.S. job market and easing of college costs could help to improve the overall student loan burden from a macro view. Additionally, better job prospects and increases in wages should help to improve the financial landscape for those who are servicing their debt. Nevertheless, the student loan debt situation will take some time to improve. Yet, we do not see the same systemic risks for the economy or financial markets that we experienced during the U.S. housing crisis. A college degree generally is a good investment for future earnings potential. It is important for borrowers to understand how to pay for their college degree and to make sure that the loan burden is reasonable and manageable.
1 Federal Reserve Bank of New York quarterly report on household debt and credit, March, 31, 2018.
2 Pew Research Center, 2016.
3 Wells Fargo Securities, “Student Debt: a Rising Economic Tide Lifts All Boats?” May 10, 2018.
4 Gallup, February 4, 2016.
5 Federal Reserve Bank of New York, March 31, 2018.
6 Wells Fargo Securities, “Student Debt: a Rising Economic Tide Lifts All Boats?”, May 10, 2018.
7 Bureau of Labor Statistics Consumer Price Index (CPI) through the first quarter of 2018.
8 Strategas and the Institute for College Access and Success, May 15, 2018.
10 Federal Reserve Financial Accounts and Strategas, May 15, 2018.
11 College Board, “Trends in Student Aid: 2017.”
An index is unmanaged and not available for direct investment.
The Consumer Price Index (CPI) produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.
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