Student Loan Debt: Crisis or Overblown Hype?

Economists have long used the term "bubble" to describe a dangerous financial trend that threatens the health of a particular industry or economy, often ending with disastrous effects if the bubble collapses or "pops."

Bubbles date back centuries, with the first on record occurring in 1634 in Holland, where the tulip market collapsed, leading to major losses from hundreds of speculators. Over the course of history, bubbles have popped and swallowed major economies, just as the real estate collapse of the mid-2000s did to the U.S. economy.

Student Loan Debt Bubble

Today, according to the front-page of every major national news outlet, and every political pundit and presidential candidate, the next bubble threatening millions of Americans is the overwhelming financial burden of student loan debt. And, if true, this financial crisis is impacting not only college students, but also their parents and grandparents who co-signed on the loans for them.

So, just how serious is the looming student loan bubble?

Student Loans: What the Numbers Say

The Federal Reserve Bank of New York (FRBNY) recently released a study on student loan debt by researchers Meta Brown, Andrew Haughwout, Donghoon Lee, and Wilbert van der Klaauw. In it, the FRBNY emphasizes the growing problem looming on the student loan front with these startling results:

• Of the 241 million people in the United States who have a credit report with Equifax, approximately 15.4% -- or 37 million -- hold outstanding student loan debt.
• The average outstanding student loan balance per borrower is $23,300. About one-quarter of borrowers owe more than $28,000; about 10% of borrowers owe more than $54,000. The proportion of borrowers who owe more than $100,000 is 3.1%, and 0.45% of borrowers, or 167,000 people, owe more than $200,000.
• Borrowers between the ages of thirty and thirty-nine have the highest average outstanding student loan balances, at $28,500, followed by borrowers between the ages of forty and forty-nine, whose average outstanding balance is $26,000.
• About 27% of the borrowers have past due balances, while the adjusted proportion of outstanding student loan balances that are delinquent equals 21%.

1T Day: Student Loan Debt Hits $1 Trillion

To make matters worse, financial pundits dubbed April 25, 2012 as "1T Day," meaning the total amount of student loan debt hit the $1 trillion mark. Back in 2010, the amount of U.S. student loan debt surpassed the total amount of credit card debt, and it continues to grow.

The media spotlight on student loan debt has grown more pervasive amidst the ongoing Occupy Wall Street social advocacy movement, even triggering an offshoot called Occupy Student Debt.

Federal Student Loan Rates to Double

More recently, that spotlight has focused on legislation in Congress to keep federally backed student loan interest rates at the current level of 3.4%.

Under federal law, the interest rates on federal student loans are set to double from 3.4% to 6.8% in July. This sounds shocking until you realize the rate increase would only affect new loans. If Congress doesn't stop the increase, the rate hike will end up costing the average federal student loan borrower an additional $6 a month. Granted, $6 a month can add up over the life of the loan, but is it so extreme that it warrants the "crisis" label? In reality, the hype around student loan debt may have more to do with politics than alleviating the student loan debt burden.

If Congress can't agree on how to pay for the continued rate cut on federal student loans -- a dollar cost that Congress pegs at about $6 billion -- the rates will double to 6.8% come July. Republicans want to pay for the 3.4% rate by taking the money out the government's health care insurance fund. Democrats want to pay the $6 billion offset by hiking taxes on wealthier Americans.

Avoiding the Student Loan Debt Trap

While Congress tangles over the offset funding issue, what can consumers do to alleviate their exposure to any student loan bubble? The good news: there are options that proactive consumers can take to avoid falling into the student loan debt trap.

If you start early and plan ahead, while your children are still young, you may be able to leverage college savings programs that offer tax-free savings along with solid asset growth potential:

• 529 College Savings Plans -- Similar to a 401k plan for retirement, 529 plans allow families to save money (tax free) for college.
• 529 Tuition Savings Plans -- Similar to the 529 plan, but much more limiting, these plans are also administered by the states and allow a family to invest for a fixed tuition rate. This option only covers tuition and will limit the student to specific schools, so make sure you research or consult with an adviser to make sure you make the right choice.
• Coverdell Education Savings Account -- Similar to a Roth IRA, this option allows families to deposit funds into a tax-deferred account. As long as the money is used to pay for college, there are no tax liabilities for withdrawals. However, the plan is subject to income limits but it allows more flexibility in paying for practically any education related costs.

If time is short, and you have a child nearing, or already in college, you may be able to curb costs by examining financing options that go beyond student loans, including:

• Free Money. Via public and private resources, there are millions of dollars available to students in the form of scholarships and grants that, unlike loans, do not have to be paid back. While there are qualifications that have to be met, most are highly doable. The key is to apply early, and often --and don't limit yourself to just one option. Visit www.fafsa.ed.gov to apply for federal and state grants through FAFSA, and check out Fastweb's scholarship database, a great place to start your scholarship search.
• Less Expensive Schools.  Ivy League schools don't have a monopoly on a great education. To keep costs down, start at a state or junior college, earn superior grades, keep saving money, and after two years, consider transferring to the college you had your heart set on.
• Leverage Government Help. Students steering a course toward public service can, after legislation passed in Congress in 2010, cap total student loan payments at 10 years. As long as public service graduates have a steady repayment record, they are eligible to have the rest of their loan forgiven. Graduates of all types can also apply to have the government cap monthly payments at 15% of discretionary income, considerably easing the monthly student loan payment burden.

If you've exhausted all options and student loans are the only option left, aim to minimize the total cost by choosing a more affordable, low fixed-rate federal student loan. Private student loans often come with variable interest rates, and don't carry the additional perks like income-based repayment and public service loan forgiveness options that are included under federal student loans.

If you analyze your options and are smart about the financial choices you make, you won't fall victim to the growing student loan debt problem.

As the old adage goes, an ounce of prevention is worth a pound of cure, and nowhere is that adage more appropriate than it is right now in the student loan financing market.

Adrian Nazari is the Founder and CEO of CreditSesame.com, a free personal finance resource that gives consumers the power of bank-level analytics — providing comprehensive credit and debt analysis, monthly access to your free credit score, and personalized savings advice to help improve your finances, build wealth, and save money.

 

Follow Adrian Nazari on Twitter: www.twitter.com/CreditSesame

Comments

[Debt Free Teen]

10:27 AM on 07/19/2012

Finally someone who says that student loans aren't a necessity. It's hidden in the article but it's there! We don't all get everything we want and the sense of entitlement that some people my age have is ridiculous! I plan on being a role model for all those students who want to find a better way and go through college without debt!
Chase

[ageofknowledge]

01:43 PM on 06/26/2012

The bubble is going to grow wildly in the near future as interest rates double and the costs soar much higher in a labor depression of no jobs where immigrants are imported as quickly as possible to snap up what jobs are created. This bubble is going to pop.

[Gett N Mi Bellee]

01:12 AM on 06/12/2012

Woopidie Doo! Doesn't matter what the interest is, that's not the problem. The problem is that the president I voted for 3 years ago turned his back on me for three years and suddenly offers to try and keep my loan rates at the status quo (after sanctioning the elimination of subsidized loans over medicare reform for the boomers who caused this mess as a way to help balance spending) as though its something that I should be doing kartwheels about. Bottom line: I'm at a top 10 law school that promised me a sack of lies concerning job opportunities. There is a real chance that I will be in debt 200k at graduation (w/ out scholly, I would be 300k, and I had no student debt previous to law school--so I don't want to hear it). If I can't find work in the legal industry by the time I graduate in 2014, a zero percent interest rate will not keep me from (1) divorcing my wife to protect her and my kids from any possible reprecautions do to my failure and (2) blowing my brains out to be certain that they will not be affected.

[Hudson Gardner]

08:40 AM on 06/08/2012

Your fixes don't mention anything about the people who are part of the group that owes over 1 trillion in debt.

[MamaShoob]

10:09 AM on 06/07/2012

Thank you! I am in college, I'm an adult working full time with a house and kids to take care of as well. I've listened to some of my younger colleagues talk about how much student loan debt they have and I finally started asking why. Quite a few of them said "Oh I used the money to buy a car." or "I used it to pay my apartment bills so I didn't have to stay in the dorm or live at home" (even though they went to college half hour from their house or "I used it to go away on spring break." Uhmmm not one of those things has anything to do with their actual classes or books. There are so many scholarships out there that people don't apply for because they just don't look. When my daughter goes into 11th grade in a year and a half, I'll be sitting down with her on the numerous scholarship/grant websites and beginning to apply for them because she can at that grade level. Kids just arent' always smart about their money and parents need to be more involved in their continued education so thousands of dollars in loan debt isn't there when they graduate.

[fatosgjakova]

01:37 PM on 06/06/2012

Market economies are susceptible to "bubbles" -- where the price of an asset rises high above its real value. These bubbles then burst, leading to the destruction of large amounts of wealth. The price of paying for overpriced education is above its real values, especially in this economy.

Every single person in congress should go back to college and take econ 101. High demand, generates high tuition prices. Except in our case the demand to go to college is an artificial demand, fueled by the government which gives out guaranteed student loans. That is why tuition goes up. Demand & Price. Demand is fake, it's artificial demand. These loans are guaranteed by the government to be paid back. There is not risk on these loans. It is a one way deal. The students have no say in it.

The solution to all this, to avoid this bubble is to bring back student loan consumer bankruptcy protection. If there was a bankruptcy consumer protection, these loans will not be guaranteed loans. Otherwise down the line the bubble will kick in and people will claim bankruptcy no matter what the law says. They will just give up paying. I guess that is depression, recession or whatever you want to call it.

The sooner we bring back bankruptcy protection back the soon things will get back to normal.

[Brian Ransdell]

11:15 AM on 06/06/2012

Here is an idea for student debt relief that will provide hope to millions of Americans AND stimulate the economy. This is not "the solution", and that many things must happen before we get control of this student lending bubble, but it is one avenue of relief that could be implented rather easily by Congress.

I want Congress to provide an exemption to Section 170 of the tax code allowing for donations to student debt to be defined as charitable contributions, and therefore be deductible from income. I've started a petition on Change.org titled "A New Approach to the Student Debt Crisis".

I envision large corporations, who annually set aside money for charitable contributions already, buying the idea that if they designate a portion of those charitable contributions toward student debt, then they could free up that equivalent amount of cash for student debtors (consumers), and immediately impact the US economy. First, Congress must provide the incentives for these corporations. This is a new idea using money that already exists for such a purpose, and would be completely voluntary. It is not loan forgiveness which I think is very unlikely to pass.

In 2010, five corporations giving the most to charity collectively donated over $1.26 BILLION. If some of that money was used to pay student debt our whole economy would see the benefits of more cash in the hands of young educated consumers.

http://www.change.org/petitions/a-new-approach-to-the-student-debt-crisis

[David Faisel]

03:24 PM on 06/07/2012

How about instead: If personal loans, mortgages, business and credit card loans don't follow ONE for life, why should a student loan. There is no difference. Money is money.

If the other loans are dischargeable, then student loans should be too.

[BlairCase]

10:09 AM on 06/06/2012

The average student debt of $23,300 is about the same as a new car loan $23,300.

[MamaShoob]

10:10 AM on 06/07/2012

Good point and one I stated as well. I have a few friends who used their student loan money to buy a new car rather than towards their tuition and book expenses.