Are Student Loans the Next Big Bubble to Burst?
By Kevin D. Mahn, President and Chief Investment Officer, Hennion & Walsh Asset Management
Many have claimed that outstanding student loan balances, which seemingly continue to grow, may be the next big bubble to burst that may have a material impact on the U.S. economy. As a result, I thought it would be appropriate to conduct some research into the current state of the student loan market and assess how large of a potential future problem this may pose.
According to an article by Mark Kantrowitz on Savingforcollege.com, there was a total of $1.6 trillion in student loan debt as of the end of the first quarter of 2019. To put this in context, the amount of student loan debt in the U.S. is larger than the 2019 estimate of gross domestic product (GDP) of 173 of the 186 countries/territories tracked by the International Monetary Fund (IMF). It also represents approximately 7.5% of the GDP in the United States. The amount of student loan debt has also grown in recent years. For example, in 2014, student loan debt totaled $1.3 trillion and thus has increased by approximately 23% in less than 5 years. Looking ahead, it is estimated in the same Savingforcollege.com article that student loan debt outstanding will increase by another 25% to reach a total of $2 trillion by the end of 2023 / beginning of 2024. To help put these increases into perspective, average hourly earnings in the U.S. (while they have been accelerating more of late) have risen by an average of 3% on a year-over-year basis over the past 30 years according to a March 8, 2019 MarketWatch article by Jeffry Bartash.
The amount of student loan debt outstanding is currently spread across 45.1 million borrowers. Since there are approximately 329.1 million people in the United States according to 2019 data from the United Nations, this means that roughly 1 in every 7 people in the United States has an outstanding student loan balance. Given the $1.6 trillion in outstanding student loan debt, this equates to a per borrower average balance of $35,477.
A few questions arise after reviewing these statistics:
1) Why does the amount of student loan debt continue to rise?
2) Can students reasonably be expected to repay these loans in the future and what happens if they do not?
To answer the first question, it is critical to understand that the cost of higher education at four year colleges continues to rise, exceeding annual increases in inflation. While the costs of attaining a college degree (including tuition, other fees, room and board) vary significantly across public universities and private universities, the overall national trend has moved higher over the last couple of decades. According to the College Board, from 1988/1989 to 2018/2019, average tuition and fees tripled at public four-year institutions and more than doubled at public two-year and private nonprofit four-year institutions, after adjusting for inflation. Where do we stand now? Consider the following published 2018/2019 total fee averages based on data from the College Board:
Recognizing that these are just averages, there are some universities that may have much lower total fees and other that may have significantly higher fees. As it relates to the latter, Harvey Mudd College, followed closely by the University of Chicago, was the most expensive college in the U.S. for the 2018-2019 academic year, according to Statista, with an annual cost of $75,003, which equates to a total cost of $300,012 over four years.
Now factor in that the median household income in the United States, according to the latest data available from the Census ACS survey in 2017, is $60,336 and it is hard to imagine how most American families can afford a four year college education for one or more of their children. Grants, merit scholarships and athletic scholarships are helpful but are not awarded to all students and/or often are not enough to cover the total college costs. Student loans fill the affordability gap but certainly come at an expense to the student and potentially to the economy as a whole. As long as student loans continue to fill the affordability gap, it is hard to imagine colleges having the incentive to significantly lower their fees outside of remaining competitive with other colleges in a similar perceived category. Yet, college degrees are essential these days and often a basic requirement for being considered for most positions with reasonable salaries and benefit packages and colleges likely take this into consideration when setting their tuition levels. The two charts from J.P. Morgan Asset Management below will help to illustrate the importance of having a college degree in today’s job market.
Source: J.P. Morgan Asset Management, BLS, FactSet, Census Bureau. Unemployment rates shown are for civilians aged 25 and older. Earnings by educational attainment come from the Current Population Survey and are published under historical income tables by person by the Census/center> Bureau. Guide to the Markets – U.S. Data are as of September 25, 2019.
There are several different types of student loans available. The primary difference involves whether the loan is a federal loan or a private loan. Most loans outstanding are federal loans but students and their families sometimes also turn to private lenders (Exs. banks, credit unions, etc…) if the amount of the federal loans they receive is not enough. Here are some of the key differences between federal loans and private loans:
According to NerdWallet, private student loans make up approximately 7.6% of total student loans outstanding as of their September 20, 2019 article while federal loans comprise the remaining 92.4%.
Once the student graduates from college with their four year degree, they then carry with them the burden of paying off their student loan(s). Their ability to repay their loans is a function of their ability to become employed and the level of wages they are paid during their employment. However, finding a job and earning a reasonable level of income can be challenging for many recent college graduates. Consider that in the U.S., while the overall unemployment rate is currently just 3.7%, the rate of unemployment for those between the ages of 20 – 24 is 7% (7.9% for Men and 6.2% for Women). For those that do find work in entry level positions, the average annual salary for those in the 20 – 24 age group is $29,770. This average rises to $41,951 for those in the age range of 25 – 34 but still creates budgetary issues for those trying to pay off their student loans.
Many federal loans have standard repayment plans, and some have income-driven repayment plans which can extend the timeline for having to repay the loan to 20 or 25 years. This may be necessary for some students to repay their loans in their entirety. Consider that if the average student loan balance is $35,477 (as stated earlier) and a borrower is applying 10% of their annual average income of $29,770 to pay down this debt, this would take them approximately 12 years, not accounting, of course, for additional accrued interest. The amount of potential additional accrued interest is not insignificant. According to Value Penguin, interest on federal student loans currently stand at 4.5% for undergraduate loans, 6.1% for unsubsidized graduate loans and 7.1% for direct PLUS loans. Of course, if borrowers wages rise, or they are able to apply a large percentage of their annual average income to pay down their loans, this timeframe could be less. Clearly, wages and the jobs market play a large role in the ability of borrowers to repay their student loans.
What happens if the borrower is not able to repay their student loan? Borrowers of federal loans do have options if they are having difficulties repaying their loans as they can postpone certain payments through deferment or forbearance. Interest does accrue during these postponements though unless the loan is subsidized. According again to NerdWallet, as of their September 26, 2019 article, there are 3.4 million borrowers with federal loans in deferment, 2.7 million borrowers with federal loans in forbearance and 5.2 million borrowers with federal loans in default. You may be surprised to realize that balances remaining on federal income –driven repayment plans are forgiven after a certain period of time – generally 20 or 25 years – depending on the particular type of plan. If you are wondering who bears the brunt for the amount forgiven in these situations, consider that approximately 92% of student loans in the U.S. are owned by the U.S. Department of Education according to a study by MeasureOne in December of 2018.
Given that student loans now account for the second largest component of U.S. household debt, behind only housing related loans, we will continue to monitor the state of the student loan market as a potential “bubble threat” given the implications on the U.S. economy as a whole and similarly, will also monitor the health of the U.S. economy given its implications on the state of the student loan market.
Disclosure: The accuracy of this information is from sources we believe to be reliable but is not guaranteed.