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Tuesday, December 6, 2016

By Benjamin Landy

Policy Associate, The Century Foundation

By nearly every measure, American households have made significant progress repairing their balance sheets in the four years since the Great Recession. Total credit card debt has fallen $187 billion, stabilizing at late-2006 levels, and mortgage debt is still dropping, down over $1.2 trillion since 2008. Consumers are getting better at paying their bills on time, too: the number of delinquent borrowers behind on their payments by 90 or more days has fallen substantially in almost every credit category.

Student loans remain the glaring exception, soaring to $966 billion last quarter as college costs—and applications—continued to rise unabated. That’s nearly triple the debt that students held in 2004, thanks to a 70 percent increase in the number of borrowers and an average loan balance among indebted graduates that passed $26,600 in 2011.

Student debt would not be such a problem if borrowers were finding jobs and paying their bills. But the number of former students behind on their payments has increased substantially in the past year, even as other consumers have been finding their economic footing. According to the Federal Reserve Board of New York, the share of student loan balances 90 or more days delinquent surged to 11.7 percent in the last two quarters—three percentage points higher than the same time last year—elevating student loans, for the first time, to the ignominious distinction of having a worse repayment rate than credit cards.

Yet even that figure underestimates the severity of the delinquency crisis. Among borrowers who have already entered repayment—excluding those in their post-graduation grace period, or in deferral or forbearance for economic reasons—the delinquency rate is roughly twice as high.

It’s hard to know what to make of this unexpected downturn among college graduates.

The first impulse is to blame the economy—specifically high unemployment—for borrowers’ sudden inability to manage their debts. But the unemployment rate for people over age 25 with a bachelor’s degree or higher was just 4.2 percent last month, far below the 9.2 percent rate for those with only a high-school education. And while the numbers are less clear for recent graduates (one widely circulated story reported half are jobless or underemployed, but did not differentiate between the two), there is nothing to suggest that their job prospects worsened considerably in the last year as the broader economy recovered.

Mark Kantrowitz, publisher of FinAid.org and an expert on student loans, told me he thinks the beleaguered college graduate narrative is overplayed. “When you look at the data and you see unemployment rates for those with bachelor’s degrees or associate’s degrees, they’re much lower than the figures pushed by people who are trying to claim that there is a bubble,” Kantrowitz says. “A lot of people seem to have a vested interest in [that story], so they either misinterpret the data because they aren’t familiar with it or they deliberately mischaracterize the data to push their point.”

At the same time, he admits, default rates tend to be a lagging indicator of unemployment. The ability to apply for an economic hardship deferment or forbearance means an unexpected job loss may not turn up in the delinquency data for months or even years after the borrower begins to struggle.

As a result, the recent delinquency trend may be driven by borrowers who graduated or entered the job market at the height of the recession and have now reached the end of the maximum three-year deferral period allowed under the federal loan program. The large spike in delinquencies in the second half of 2012 appears to support this theory, as large numbers of students who left school in 2008 and 2009 would have had to enter repayment this year. If that were the case, we might expect delinquency rates to get worse before they get better.

student loan chart

Kantrowitz thinks there is more to it than that. He suggests that the delinquency data are distorted in part by an unintended loophole that allowed borrowers before 2006 to consolidate federal student loans while still in college, locking in lower in-school interest rates. The early repayment status loophole was closed by the Higher Education Reconciliation Act of 2005, but not before the savviest borrowers entered early repayment at the lower rate.

“Every 1 percent increase on the interest rate on a federal student loan is, on average, a 5 percent increase on the monthly payment of a 10-year term, and 9 percent on a 20-year term.” Fast-forward a few years, and the remaining borrowers from the 2005-2006 cohort who weren’t paying attention to the loophole opportunity are now the most likely to be in default.

Still, seven years have passed since the Department of Education closed the loophole, and unsubsidized federal interest rates have been locked at 6.8 percent since 2010. Even if the early repayment status loophole caused some of the increase in the delinquency rate, its effect should be largely dissipated at this point.

Perhaps indebted college students have simply reached a breaking point, as the combination of rising college tuition, growing loan burdens, underemployment and falling wages becomes unsustainable – call it student financial fatigue.

According to a recent TransUnion study, more than half of student loan accounts are in deferred status, as more borrowers attempt to avoid their loan balances until the economy improves or they are forced into repayment. Some return to school for a graduate degree, amassing more debt in exchange for a competitive advantage in the job market, while others manage their debts by retreating from the middle class consumer economy—delaying homeownership, marriage and children until their loans are paid.

But if the souring delinquency data are any indication, none of these strategies are working particularly well. Until policymakers find a way to address the underlying problem of soaring college costs, or design a better structure for the federal loan program, the bills will keep coming.

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