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How Much Student Debt Is Too Much?

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It used to be that Americans had too much debt. Now they don't have enough. The Wall Street Journal reported over the weekend that "household thrift" is a key reason the economic recovery has been so weak.

But student-loan debt seems to be immune from this newfound penny-pinching. Students and their families are still taking on record amounts of debt to pay for a college education. Despite some debate over the exact amount of outstanding student-loan debt right now, the number has already surpassed credit-card debt and is expected to cross the $1-trillion mark for the first time this year, says Mark Kantrowitz, publisher of FinAid, a Web site offering student-aid advice and tools.

The growing burden of those payments in a tough economy is becoming a hot political issue, especially in recent weeks with the Occupy Wall Street movement. That's one reason President Obama announced new measures on Wednesday to expand loan consolidation and income-based repayment programs a bit.

Far more radical or broad-based ideas have been proposed recently, including forgiving all student debt to stimulate the economy or expanding income-based repayment to everyone.

Most Students Need a Stake in Paying for College

What worries me in some of these debates is that student-loan debt of any amount is portrayed as the villain. Students or their parents at most income levels should have a stake in paying for college. They are, after all, getting something in return. Taking on a student loan seems like a good investment, when placed next to the lower unemployment rate for college grads and the lifetime payoff of a bachelor's degree.

"The asset you are borrowing against is human capital," explains Justin Wolfers, an associate professor of business and public policy at the University of Pennsylvania. Unlike home values, the value of human capital isn't likely to drop sharply in a year, he says.

More than half of the students at public and private four-year colleges are now graduating with debt, according to the College Board. The average per borrower at public colleges is $22,000; at private colleges it's $28,100. It has been reported that the financial payoff of a bachelor's degree is $550,000 over a person's lifetime, so the average level of debt still seems like a good investment.

Of course, don't tell that to recent college grads who are unemployed or working in jobs that don't require a bachelor's degree. In a global economy, there could be a limit to the human capital of many college grads in the United States (read: lifetime income), so while a college degree might make good economic sense, one at any cost probably doesn't.

And that's where the debate on student debt should be focused: How much is too much? While economists are confident that a college degree is worth more than just a high-school diploma, "there is less evidence that an expensive college degree is worth it compared to a cheap one," says Wolfers, the Penn economist. "Going to college is worth it, [but] doing so expensively might not make a lot of sense."

That means big trouble for expensive colleges where students graduate with higher-than-average amounts of debt. Those institutions have been helped by the association of price with quality in many people's minds, the wide availability of loans, and a willingness of students and families to take on a lot of debt.

End of an Era of Easy Money for Student Loans

Those days are probably coming to an end. If we're indeed entering an age of austerity in Washington (a big if), the availability of student loans will probably tighten. The federal government makes 90 percent of new student loans, and as Mark Zandi, chief economist at Moody's Analytics points out, it doesn't do so based on the creditworthiness of borrowers. "The federal government will have to do some form of better underwriting, or otherwise they will get swamped with losses," Zandi says.

Students and their families will also probably get clearer financial-aid offers from colleges, if a push by the federal government for better disclosure succeeds. One hope is that clearer aid-offer forms will help students better understand the type (especially loans vs. grants) and amount of aid they qualify for, and will make it easier for them to compare aid offers from different institutions.

With potentially less federal loan money available and more information, perhaps students and their families will begin answering the question: How much is too much?