Orlando's Outlook: Student loan debt's growing economic drag

08-31-2018

Bottom Line As we approach the Labor Day weekend, marking the unofficial end of summer, our college students are heading back to school with a looming financial crisis awaiting their eventual graduation. According to a recent Federal Reserve study, student loan debt hit $1.52 trillion for the first time earlier this year, up from $611 billion only a decade ago. Student debt, then, has soared at an annualized rate of 9.5% over the past decade, more than quintupling the relatively modest 1.7% rate of yearly growth for the nominal consumer price index (CPI).

After housing-related debt of about 71%, student-loan debt consumes 11% of the nation’s consumer debt, surpassing auto (9%) and credit card debt (6%). There are more than 44 million people in the U.S. with student loan debt, and about 68% of those who graduate from public and nonprofit colleges today are burdened with student loans. The average American student owes $37,000 and the average student household owes $49,000 in academic loans, and they make an average monthly payment of $350. Nearly 3,000 students default on their student loans every day.

In our view, as the nation’s 92 million millennials gradually pay off their education debts over the next decade or longer, the growing student loan burden will continue to have a deleterious impact on their economic decision-making, such as when to marry, how large a family to have, when to buy a house, when to buy one or more cars, how to invest and when to retire.

College education is expensive It’s imperative students invest in themselves to acquire skills that will differentiate them in a competitive job market, but a college education has become increasingly expensive. The College Board estimates the annual, all-in list price for undergrads in 2018:

  • Community college: $18,000
  • Four-year public college for in-state students: $25,000
  • Four-year public college for out-of-state students: $41,000
  • Four-year private non-profit college: $51,000
  • Elite four-year private non-profit college: $70,000

Student strategies to economize may include knocking off the first two years at low-cost community colleges and then finishing at in-state public colleges. While many dream of attending the elite private schools (Harvard, Princeton, Yale, Stanford, etc.), it’s difficult for most to afford the elevated price tag without a generous grant package. Perhaps those financial resources would be better allocated to a part-time night program at a top graduate school, while getting tuition assistance (and a paycheck) from a full-time employer. In fact, many companies are beginning to offer student loan benefits to attract younger workers, by offering to help them pay off their undergraduate loans.

Moreover, college may not be for everyone. Learning a trade and serving an apprenticeship to become a much-in-demand carpenter, electrician or plumber may be a much better career path for some than becoming an unemployed philosopher with a huge amount of college debt. In most cases, student debt can’t be discharged in bankruptcy, so people continue paying until their loan is fully repaid, which weighs heavily on young consumers for years, likely changing their behavior.

What are possible solutions? Our elected officials in Washington have very different approaches in their attempt to resolve this crisis:

Democrats typically advocate for a debt-free college experience: free community college for everyone and no tuition for public colleges for families earning less than, say, $100,000. In addition, with benchmark 10-year Treasury yields now at 2.85%, the federal government could refinance existing loans (with rates perhaps as high as 10%) that are currently burdening some borrowers. Finally, new graduates could cap their student loan payments at a percentage of monthly income, and become eligible for loan forgiveness after 20 years, regardless of loan balance. If they work full-time in the public or nonprofit sector for a decade while making their monthly payments, the federal government will forgive the remaining loan balance. One potential problem is that some students might be incentivized to take out large loans and accept low-paying public-sector jobs to qualify for an income-driven repayment plan, paying only a small amount of their large loan each month before it is forgiven. In sum, these approaches are expensive, resulting in higher taxes, increased federal debt and slower economic growth.

Republicans generally believe less government is better government, and that students should responsibly manage their own education as an informed consumer. The government should stop providing loans to college students, they suggest, and shift the opportunity to the private-sector loan market, which will give students more financing options. Increased competition likely would drive down the cost of financing and tuition, too.

How student-loan debt affects millennials’ decision making:

  • Housing While many millennials want to buy a home and participate in the “American Dream,” student loan problems prevent them from getting approved for a mortgage due to loan delinquency, a high debt-to-income ratio or an inadequate down payment. An estimated 35% of the decline in home ownership by young Americans between 2007 and 2015 is linked to student loan debt, and homeownership rates for households with student loan debt is always below the rate for households without student loan debt. Millennials also are living with their parents longer than baby boomers did in order to save money. Some 23 million millennials are now living in their parents’ home, a 64% increase over the 14 million 18 to 34-year-olds living with their parents in 1975. This has forced people to remain in their starter homes rather than move up, because the entry-level millennial buyer is absent.
  • Auto Millennials also are reluctant to spend big bucks on a cool new car due to student loan debt, which helped to spawn the rise of car- and ride-sharing alternatives such as Zipcar, Uber and Lyft. These options are cheaper than owning a car, when also considering insurance, parking and maintenance, and there has been a 13.8% decline in millennial driver’s licenses over the past decade.
  • Fertility Millennials are pushing off having kids, with the fertility rate at a cycle low of 1.84 births per woman, below the replacement rate at 2.1 and well below the cycle peak of 3.6 in the 1950s. Millennial women are focused on completing their education and establishing their careers first, but they also cite the expense of having children. The average cost of a child is $233,610, which millennials with large student loan debt can’t afford.
  • Investments Millennials are underinvested. From 2001 to 2007, 52% of Americans aged 18 to 34 owned stocks, compared with only 38% from 2008 to 2018, due in part to the investment trauma from the Great Recession. In addition, millennials don’t want to risk losing money with student loans hanging over their heads.
  • Retirement Two thirds of millennials have literally zero saved for retirement. The median savings among the remaining one-third is only $19,100, which puts the vast majority of them far behind where they need to be to retire comfortably. Insufficient saving for retirement will force them to rely more heavily on Social Security benefits, which will place an added strain an already struggling program.

Research assistance provided by Federated summer intern Audrey Randazzo.

We wish everyone an enjoyable Labor Day weekend. Happy birthday, Lorraine!

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