Student loans: the next recession risk?

By Russell Price, Chief Economist, Ameriprise Financial

Woman studying a textbook in a college library

Key Points

  • Since 2006, student loan debt has tripled and now represents the second-largest category of consumer debt.
  • At the same time, growth in student debt has slowed significantly in recent years.
  • The burden of student loans is unlikely to adversely impact the broader economy, in our view.

September is traditionally back-to-school month across the United States, so it seems like a good time to evaluate the much-publicized concerns about excessive student loan debt.

The Federal Reserve began measuring student loans as an independent category of debt in 2006. Today, after only 13 years, the balance of student loans outstanding has more than tripled, rising from $481 billion to $1.6 trillion.1

As is often the case when debt grows at a rapid rate, there are adverse consequences for millions of Americans. Many are now struggling to keep up with their loan payments and are enduring significant financial hardship as a result. 

 

The risk to the economy appears limited

Struggling with student loans can be a very challenging situation. However, the risk to the broader economy is quite limited, in our view. 

A relatively small percentage of borrowers account for an out-sized dollar amount of the debt. The risk that loan defaults will cause problems in the financial system is offset by the fact that the federal government backs most of this debt, limiting the potential risk to the broader system. At the end of this year’s first quarter, 92% of student loans outstanding had the backing of the federal government under various programs, according to the Department of Education.2

 

Excessive burdens are the exception, not the norm

Approximately 44.7 million Americans had some student loan debt at the end of 2018, according to the Federal Reserve. Simple math tells us that this works out to an average of $35,780 per borrower. Averages, however, can distort the reality of a situation, and that’s especially true in this case. An evaluation of the data shows a majority of borrowers actually carry small loan balances. This means that a relatively small number of borrowers accounts for a significant percentage of the debt. 

According to the College Board, just 9% of borrowers were responsible for 40% of student loan debt, as of March 2018.3 At the same time, many of these borrowers were in advanced or professional degree programs (such as law or medicine), which typically lead to higher starting salaries. These borrowers are also well-positioned for substantial lifetime earnings, so most should have the wherewithal to pay off their loans on a timely basis. Conversely, 56% of borrowers owed less than $20,000 and were responsible for just 15% of the outstanding debt.3

 

According to studies from the Federal Reserve and others, two groups stand out as having the highest loan default rates:

  • Those who did not finish their educational program. Failing to complete a program means an individual incurs costs without realizing the financial benefits of a degree.
  • Those who attended for-profit institutions. College Board data shows that a higher percentage of students attending for-profit institutions require loans to fund their education, and for amounts that are much larger than average. Meanwhile, Federal Reserve surveys and others show default rates for this group are double that of all student borrowers in aggregate.

 

Debt accumulation has slowed dramatically

Fortunately, growth in student loan debt is slowing. College enrollment has been declining since it peaked in 2010, thus slowly reducing demand for loans. Additionally, the availability of grant money (funds that do not have to be repaid) has grown, and students are making good use of it. Federal loans as a percentage of total student aid declined from 41% in the 2008 – 2009 school year, to 30% last year. Taking up the slack, institutional grants rose from 19% to 26% over this same period.3    

 

 

Many options for educational needs

College funding is a complex matter for any family and one that requires proper planning. Be sure to educate yourself on the broad swath of financial aid programs available, particularly state, institutional and federal grant programs. You’ll also want to work with your financial advisor to navigate the many tax-advantaged savings programs that can help you meet future educational expenses. As the old saying goes, preparation is the key to success — not just for getting into college, but in paying for it as well.