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:
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:
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:
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.
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