Broke and Hungry… The story behind our student debt problem
By George Bailey
One morning, I stood behind a young lady who was trying to pay for her breakfast in pennies she carried in a zip-lock bag. She counted each cent and got it wrong at least three times. And every time she needed to start over.
It was frustrating, and I was losing patience as my mind began to judge – Doesn’t she know how to convert those cents into dollars… She knows how to count but can’t add?…. Thank you education.. and so on. I must have waited at least 10 minutes pretending to be patient, but it felt longer than that. Relieved when she got it right, she turned around and said…
I am so sorry…. just broke and hungry.
That was Susy, a recent graduate pursuing her passion with a degree in history at a decent school. She struggled to find a job straight out of school during the financial crisis and had lost her part-time job a few weeks ago. She couldn’t save much with a pile of debt; the most significant of which was her student loan (nearly $45,000). Susy might have been unlucky with keeping a sustained job, but she is not the only young person with a significant debt burden who is either unable to repay her debt or cannot afford a decent living while fulfilling high cost of debt.
According to a recent report published by PwC, more than 2/3rds of millennials (generally defined as those born in the early-80s through the mid-90s) have at least one loan. And more than 54% of millennials do not know how they will repay their student debt.
What is the student debt level in the U.S.?
Federal student debt in March 2016, as reported by Federal Reserve, stood at $1.3 trillion dollars, quadrupling over the last decade and more than any other type of household non-mortgage debt. The Wall Street Journal reported that the average graduate loan debt in 2015 was $35,000 compared to nearly $10,000 in 1995. That is 250% increase in a period of two decades.
The rising student debt level has been accompanied by large default rates, although there has been some recent decline in defaults (as of March 2016) as a result of Government efforts, such as the expansion of income-based repayment options. However, increased affordability does not necessarily imply all is going well.
Remember the recent financial crisis? Before the crisis, housing was “affordable”, homeowners were being approved for unreasonably high mortgages because they had repayment capacity. Demand increased and so did home prices, leading to even high mortgages making the situation worse, before the bubble burst. We know how that ended.
No, the problem here is not affordability. It is the fact that cost of education continues to increase and students are taking out larger loans.
Why is the student debt level and default rate so high?
There is some debate on the core reason behind the high student debt level. There are two main schools of thought backed by data. One school of thought points to the increase in relatively smaller balance for-profit college loans with a higher number of borrowers while the other school of thought suggests that it is, in fact, the significant increase in relatively large graduate school loans with a small number of borrowers.
While the debate continues, we believe the issue is not a binary one and both arguments hold water. In fact, as you will read below, we believe that the for-profit argument is geared towards explaining the rise in default rates while the graduate loan level argument is geared towards explaining the rise in debt level.
The rise in student debt defaults: For-profit school loan problem
A detailed study in 2015, by researchers Adam Looney from the Treasury Department and Constantine Yannelis from Stanford University, found that “most of the increase in default is because of an upsurge in the number of borrowers attending for-profit schools and, to a lesser extent, community colleges and other non-selective institutions whose students had historically composed only a small share of student borrowing.”
According to the data, student loan borrowing for for-profit colleges increased nearly four times from $60 billion in 2004 to $230 billion in 2014. The same is true for borrowings for 2-year colleges which increased from $20 billion to $70 billion over the same period.
At the same time defaults on these loans increased significantly as well. The New York Times analyzed the report and provided the following summary of student loan defaults by type of college from 2000 to 2010.
The theory behind the increase is that in the wake of the financial crisis, millions of people registered as students in the hope of improving their skills. But with community colleges having a shortage of funds and space, these new students turned to for-profit colleges, taking on loans. The result: a spike in enrollments and borrowing at these schools. For-profit students represented half of the increase in borrowers between 2003 and 2013.
Based on this data, the issue regarding the increase in for-profit student borrowing is definitely supportive of the increase in default rates.
The rise in student debt levels: Graduate school loan problem
Jason Delisle from New America points to graduate loan level increases. He blames the increasing graduate school debt on changes to federal loan programs that allow grad students a high level of borrowing. As a result of policy changes in 2006, graduate students can borrow up to $138,500 in aggregate and the limit for medical students is even higher at $224,000. He states that the more students can borrow, the more schools can charge and hence the problem of high student debt pointing to data they analyzed.
“Looking at the student debt levels of law school students, for example, there was no significant change in the average amount of debt students graduated with between 2004 ($88,634) and 2008 ($90,052). But by 2012 (after loan limits were raised), the average spiked to $140,616, and the average monthly payment shot up from $760 in 2008 to $1,187 in 2012,” he writes.
The problem seems to be complicated with the introduction of various income-based repayment and loan forgiveness programs in recent years. As an example, under the public service loan forgiveness program, borrowers who have been making income-based payments for ten years, can have any remaining student debt wiped away. This creates a potential risk to the lender, and the first rule of finance suggests that a premium must be charged to cover the costs either in the form of higher tuition cost or higher interest rate.
“When you combine that with unlimited borrowing at the grad level and then only make people pay for 10 years based on a small share of their income, it becomes clear, somewhat obvious to people who are borrowing to pay for school, they are really just borrowing money that will be forgiven,” Delisle says.
As it relates to graduate school student debt, based on Delisle analysis, for-profits are still only a small share of the problem. His data shows the following key numbers:
- Only 8% of students completing graduate/professional degrees come out of for-profit institutions.
- For-profit schools generate only 10% of the total graduate debt for students who end up owing more than $100,000.
- The proportion is higher for students borrowing between $25,000 and $50,000, at 16% of the total, but still isn’t comparable to public school or private nonprofits.
Looking at this argument, it is difficult to argue that graduate debt level isn’t part of the problem as well. It, therefore, appears to us that the two issues – for-profit borrowings and graduate debt levels – are both to blame for the rapid rise in student debt.
Why are the default rates rising?
There are numerous data sources to compile default information, but the variety of information makes it challenging to get a clearer picture. Despite the lack of clarity, one thing is clear – default rates on student loan debt are high.
The U.S. Department of Education reports annually the rate at which borrowers default on federal student loans. In September 2015, the Department announced that the cohort default rate, one of its measures it uses for reporting, declined to 11.8% from 13.7% in the previous period due to increasing efforts in making loan repayments affordable under the income-repayment plans.
However, this cohort default rate only measures defaults over a three-year period directly after a cohort of students enter repayment and therefore only capturing information on borrowers who never begin making payments on the loan or who default within three years after entering repayment. It does not provide the total default rate over the life of the loans.
To look at the current cumulative default levels, we have to consider another reported measure referred to as the cumulative lifetime default rate on student debt. This rate is reported for each year a borrower enters repayment (considered the cohort year). This rate can change annually for each cohort as more defaults occur over the passage of time. The Department reported the following data (explained in plain english below): This data suggests the following:
- Nearly 16% of students who began repayment in 2007 have defaulted on their student debt. The rates are higher for those who began repayment in 2008 (18.5%) and 2009 (16.6%) and lower for those entering repayment in 2011 (10.2%). Note however that the number of years of data (i.e., lifetime to date) between the cohorts is inconsistent. For 2007 cohort, nearly seven years have passed since repayment began and for the 2011 cohort, only four years have passed based on when the data was compiled. As such, it is likely that the 2011 cohort defaults may rise to similar levels as the other cohorts over time.
- Default rates for 2-year institutions and for-profit (proprietary) institutions are considerably higher.
Grim as the data above may seem, the problem doesn’t end there. The Consumer Finance Protection Bureau reported in October 2015 that every one in five borrowers is past-due or not making payments but not yet in default.
Unfortunately, the increase in student debt incurred to attend higher education isn’t working to get better jobs that would enable paying off that debt. The analysis conducted by Looney and Yannelis (mentioned above) shows the following for a typical borrower leaving different types of schools:
- Earning potential: Students from for-profit colleges were earning significantly less than their counterparts from selective colleges or graduate schools. For example, median earnings for a for-profit student in the second year of loan repayment was approx. $20,000 in 2011 compared to $45,000 for more selective colleges and nearly $60,000 for graduate schools.
- Unemployment rate: The unemployment rate for borrowers attending for-profit, 2-year or non-selective collective was found to be significantly higher when compared to those students attending selective or graduate school.
These charts are from the same study summarizing the issues:
This data certainly supports why the default levels are high for students attending for-profit and two-year colleges. A big part of the problem is that students are not fully appreciative of the impact the debt will have on them and how they will need to repay it. For many, this is the first foray into the world of finance and debt. Without experience in handling real world finances, it is much to expect that defaults will not occur.
Rachel Fishman, a senior policy analyst with New America confirms when stating: “Students struggle to understand exactly how student loan repayment is structured compared to how much they’re borrowing.”
How the current generation is changing with excessive student debt
What good can come to society when those who need to carry it forward are burdened with debt. There is so much opportunity we have lost by loading our generation with student loans.
It is difficult to fathom that education in the U.S. has led to the many negative repercussions in the life of a graduate:
An uncertain financial future. Nearly 65% of millennials do not have a retirement account as reported by the PwC report. How can they? With the present so burdensome, who can care much about the future.
A late family life. There are reports that suggest millennials are getting married later in their lives, if at all. Priorities have certainly shifted with every generation but it is an obvious consequence for those who are focussed on paying off debt before they start a family.
A career without passion. Given the choice of an undesired job now and a potential but un-guaranteed desired job later, the choice is obvious when you have bills to pay.
No place to call home. Once an American dream, the cost of owning a home is no longer a priority, as reported by Pew Research.
No vehicle to own. When there is a need to tightly manage expenses, this is one expense that has been chopped and there is increased reliance on the on-demand economy with good use of taxis and Uber(s). The alternative is to live and work in cities with good public transport but pay high rents, further aggravating the problem of affordability.
A recent report by Gallup found that students with over $50,000 of debt suffer adverse effects to their physical and financial well-being.
So what are we to do?
We are focussed on the gloominess of the situation because that is the reality. I was once in such a situation, so I too understand the perils of student debt. It took me nearly ten years to pay off my loan and the shocking interest. Along came a lot of sacrifices including career choices I had to make. It was not easy, but I also know it is more difficult for a lot of young people today, especially in the aftermath of the financial crisis.
Yes, the financial crisis has changed how the new generation thinks. You hear about young entrepreneurs chasing millions or billions, but they represent just a minority. The reality for the rest of us is quite different. There are more and more who are unsatisfied with their careers and their financial position.
Broke and hungry… those three words were enough for me to realize how we have ruined the opportunities for our new generation.
But what is being done about it? We have eased access to loans with abundant alternative lenders but the cost remains high. There are many others like me for whom it only takes one mistake to get stuck in a vicious circle of repaying interest payments with credit cards and expensive loans.
We need to start a movement if we want to bring about change for Susy and others like her. Our contribution, however little it may be, starts right here and with this endeavor we hope we can begin:
Learning more about the issues relating to funding student loans;
Understanding the challenges students face in their life before, during and after college;
Educate those who seek assistance using our knowledge and experience in finance.
Meanwhile, it is time we change that and voice our opinions to the government. There are very limited efforts being made by Congress who continues to fight and not compromise. We need to continue to push the agenda so call your local representatives, send in a letter – it is your right to do so. Soon we will also be reviewing the plans put forward by the 2016 Presidential candidates so you can make a sound decision about who you should vote for securing your future or your childrens’ future.
Our final words…
The future is in the hands of the new generation. We can not afford to let us fail or let them fail. We need to clear the path away from guaranteed failure and instead guide them towards success.
Let us work on this together. Let us find a way to help the new generation and generations to come. Tell us what you think are the key problems and what we should be doing as a community to change the status quo. Your comments below could be the voice of change.