Delinquency and Default
Considerable popular attention, and significant financial resources, have been dedicated to the problem of student
loan delinquency and default. Student loans become delinquent when payment is 60 to 120 days late. In 2011 the
U.S. Department of Education spent $1.4 billion to pay collection agencies to track down students whose loans are
delinquent or in default (Martin, 2012). While all types of consumer debt have some experiences of repayment
difficulty, there is evidence that something about the student loan product, or the context in which it is situated,
makes it particularly difficult to service successfully. According to Brown, Haughwout, Lee, Scally,
and van der
Klaauw (2014), the measured student debt delinquency rate is currently the highest of any consumer debt product.
Cunningham and Kienzl (2011) find that 26 percent of borrowers who began repayment in 2005 were delinquent on
their loans at some point but did not default. By 2012, Brown, Haughwout, Lee, Scally, and van der Klaauw (2014)
report that just over 30 percent of borrowers who began repayment were delinquent at some point.
And some of the
practices utilized by borrowers and lenders to cope with repayment difficulties may have the perverse effects of
deepening loans’ negative implications for student borrowers. About 21 percent of borrowers avoid delinquency by
using deferment (temporary suspension of loan payments) or forbearance (temporary postponement or reduction of
payments for a period of time because of financial difficulty) to temporarily alleviate the problem (Cunningham and
Kienzl, 2011). While this may allow borrowers to stay out of official ‘trouble’ with their loans, by stretching out the
period of total indebtedness, these practices may further retard capital development. In total, Cunningham and
Kienzl (2011) find that nearly 41 percent of borrowers have been delinquent or defaulted on their loans. Again, these
trends have effects far beyond the cohort of young adults most plagued by student loan difficulties.
Accompanying
the increase in student loan indebtedness, delinquency is also a growing problem among older adults. Among
student loans held by Americans aged 60 or older, 9.5 percent were at least 90 days delinquent, up about 7.4 percent
from 2007 (Greene, 2012).
Defaults are also on the rise. According to the U.S. Department of Education (2012), the national 2-year student loan
default rate was 9.1 percent in 2010 and the 3-year default rate was 13.4 percent. Not surprisingly, defaults occur
unevenly. Students from lower-income households are more likely to default (Woo, 2002), along with students of
color (Herr & Burt, 2005). With fewer familial resources to cushion the payment strain prompted by student loan
obligations and greater likelihood of inadequate income upon leaving college (Woo 2002; Lochner & MongeNaranjo, 2004),
these borrowers may have to confront the failed economics of student loans very shortly after
exiting higher education.
Given rising rates of delinquency and default some researchers have suggested making loan eligibility determinations on an individual basis, taking into consideration all of the circumstances faced as well as the outlook for future
ability to repay (see Akers, 2014). This concept, predicated as it is on the availability of nearly unattainable
information,
seems born of a desperate attempt to justify the continued existence of the student loan program, while
mitigating its most visibly negative effects. That is, there are too many ways in which the student loan program fails
(individuals and society), so we try to patch solutions together when the reality is that only reducing the prominence
of student borrowing as a part of the financial aid system will address the roots of the problems. In sharp contrast,
these patchwork solutions are likely to exacerbate inequality, perpetuating the survival of a program that will
continue to fail whole cohorts of aspiring college students, while diverting massive resources that could be deployed
toward more promising approaches.
Overall Debt
Since recent college graduates’ annual earnings are usually much lower than they will be during later, prime earning
years, most young adults with student loan debt are forced to rely on credit as a key mechanism for purchasing
wealth-building items like a home (Keister, 2000; Oliver & Shapiro, 2006). However, delinquent and defaulted
accounts may be reflected in students’ credit scores. For many students, this reveals another way in which student loans may haunt them as they embark on financial independence. Research by Brown and Caldwell (2013) indicates
that students with student loans have credit scores that are 24 points lower than students without student loans.
Contrary to idea that student loan borrowers face credit constraints, however, research using data from 2010 or
earlier finds that there was a positive correlation between having outstanding student debt and other debt (such as
mortgage, vehicle, or credit card), when comparing graduates with and without debt. For instance, Fry (2014) uses
2010 Survey of Consumer Finance data and finds that 43 percent of households headed by a college graduate with
student debt have vehicle debt and 60 percent have credit card debt. However, using 2012 data, Brown et al. (2013)
find that households with student debt have lower overall debt than households without student debt. They speculate
that borrowers post-Great Recession have become less sure about the labor market, causing a drop in the demand for
credit. Additionally, lenders may have become more reserved about supplying loans to high-balance student
borrowers in the tighter credit markets that followed the financial collapse.
Asset Accumulation
Student debt’s most troubling financial effects may be its constraints not on other borrowing, however, but on asset
accumulation, particularly given the emerging understanding about the significance of initial assets as catalysts for
later economic mobility (Elliott & Lewis, 2014). Research indicates that students who graduate with average student
debt may be forced to invest significantly less in retirement savings or to delay purchasing other wealth-building
items like a home during the early part of their working lives.
Critically, this may account for a meaningful amount
of the wealth inequality seen later in life between college graduates with and without outstanding student debt. In
this section we will review research on the correlational relationship between student debt and asset accumulation.
Net worth. Survey data indicate that 63 percent of young adults with student debt report delaying purchasing large
ticket items such as a car. Therefore, it is no surprise that researchers are finding that young adults with student debt
have less net worth (i.e., total assets – total liabilities) than students without student debt. For example, Elliott and
Nam (2013) find that families with college debt may have 63 percent less net worth than those without outstanding
student debt. Similarly, over the life course, Hiltonsmith (2013) finds that an average student debt load ($53,000) for
a dual-headed household with bachelors’ degrees from four-year universities leads to a wealth loss of nearly
$208,000. Fry (2014) also finds a net worth loss among households headed by a college-educated (i.e., bachelor’s
degree or higher) adult younger than 40 who has outstanding student debt. Specifically, he finds that a household
headed by a college graduate without outstanding student debt has seven times ($64,700) the typical net worth of a
household headed by a college graduate who has outstanding student debt ($8,700).
Homeownership. There is evidence to suggest that credit constraints as a result of student loan debt may force young
adults with outstanding student debt to either delay purchasing a house or to purchase it at a much higher interest
rate in the subprime loan market. The higher interest rate may make it harder to earn equity in the house and can
price indebted households out of the most desirable real estate markets. For context, Mishory, O’Sullivan, &
Invincibles (2012) find that the average single student debtor would have to pay close to half of his or her monthly
income toward student loans and mortgage payments. As a result, the debtor would not qualify for an FHA loan or
many private loans (Mishory, O’Sullivan, & Invincibles, 2012)). In line with this, Stone, Van Horn, and Zukin
(2012) find that 40 percent of students graduating from a four-year college with outstanding student loan debt delay
a major purchase, including a home.
Quantitative analysis supports descriptive findings. Shand (2007) finds that student debt has a negative effect on
homeownership rates when comparing four-year college graduates with and without debt. Hiltonsmith (2013) finds
that households with four-year college graduates and outstanding student debt have $70,000 less in home equity than
similarly-situated households without outstanding student debt. Potentially explaining this gap, Houle and Berger
(2014) find that student debt is associated with a delay in buying a home among college graduates with outstanding
student debt compared to those without outstanding student debt. Though Houle and Berger’s findings are
significant but not very strong, if we push the student loan system to perform above a standard of ‘do no harm’, this
still raises serious concerns.
Moreover, even though the effects are not strong in the aggregate, again, some groups
of students may be disproportionately affected by these pressures. Significantly, for example, Houle and Berger
(2014) find evidence that suggests these effects are much stronger among Black graduates with outstanding student debt. This is important to the question of whether student loans are helping to strengthen the ability of the education
path to act as an ‘equalizer’ in society, given the structural barriers Blacks already face in the housing market (e.g.,
Oliver and Shapiro, 2006).
Raising doubts about options to quickly maneuver away from these adverse outcomes, Shand (2007) finds little
evidence to suggest that this wealth loss is the result of credit constraints. That is, the presence of student loans on a
household’s balance sheet may not render the household unable to obtain a mortgage. Instead, households with
outstanding student debt might be averse to obtaining a mortgage for a home.
In this manner, student loans may
introduce additional levers of inequality into students’ post-college lives, artificially constraining home purchase
and, then, preventing the development of a powerful asset base (Shapiro, Meschede, & Osoro, 2013). The reason for
these differences, with regard to the role of credit constraints, might be due to the different years examined. For
example, as discussed above, Brown and Caldwell (2013) find credit scores of student loan borrowers and nonborrowers were essentially the same in 2003, but by 2012 borrowers had lower scores. Further, Brown and Caldwell
(2013) show that as credit scores of borrowers declined and student debt per borrower increased, homeownership
rates of 30-year-old student loan borrowers have decreased by more than five percent compared to homeownership
rates of 30-year-old non-borrowers.
This is a fairly substantial drop, particularly given that the overall
homeownership rate for 30-year-olds is below 24 percent. The Federal Reserve Bank of New York speculates that
the drop in housing rates post-Great Recession is due in part, not only to credit score declines, but tighter
underwriting standards and higher delinquency rates (Brown et al., 2014).
These findings suggest that student loans are simultaneously more and less alarming for the future of the United
States than commonly believed.
While student debt may not incite the next financial collapse, despite the
sensationalist claims in some popular media coverage (for discussion of this coverage, see Karsten, 2014; Harvey,
2014), the long-term and aggregate effects of these derailed asset aspirations may constrain economic mobility and
threaten the financial security of student borrowers throughout their lives, and these effects could transmit
significant, albeit indirect, economic fallout from student loans. Unfortunately, difficulties in adequately assessing
these effects, particularly on a timeline that lends itself to policy deliberations, contribute to the overly narrow frame
through which student loans are judged. Even if some of the corrosive effects of deterring homeownership, for
example, may not be felt until today’s indebted youth lack the asset foundation with which to leverage a secure
retirement (Pew Charitable Trusts, 2013), that slow-moving threat is no less deserving of our urgent policy attention.
Retirement savings.
In the American Student Assistance (2013) survey on young adults with outstanding student
debt, 73 percent of borrowers say they have put off saving for retirement or other investments. In support of this
finding, Elliott, Grinstein-Weiss, and Nam (2013) find that families with outstanding student debt have 52 percent
less retirement savings than families with no outstanding student debt. Hiltonsmith’s (2013) results indicate that
dual-headed households with a college graduate and median student debt ($53,000) have about $134,000 less in
retirement savings in comparison to dual-headed households with a college graduate and no student debt. Similarly,
Egoian (2013) finds that four-year college graduates with median debt of $23,300 have $115,096 less in retirement
savings than a four-year college graduate with no student loans by the time they reach age 73.
With so many potentially intervening factors unfolding over the next few decades, the full impact may be even
worse. Egoian’s (2013) estimates assume that seven percent of an indebted college graduate’s earnings go toward
yearly loan repayments.
This is more conservative than the recommended cutoff for unmanageable student debt of
eight or ten percent (Baum & Schwartz, 2005). That is, he finds negative effects that kick in even at levels of
indebtedness lower than recommended levels. He also bases his estimates off of relatively small amounts of debt --
$23,000, at least far less than that apocryphal $100,000 (and even less than current estimates of average debt loads),
yet he finds these relatively large effects. Moreover, his estimates assume that households will pay off their student
debt in 10 years. However, current approaches to dealing with escalating student debt largely seek to make
unsustainable debt levels more bearable by extending the period of repayment.
This makes monthly payments
smaller, certainly, but also lengthens the period of depressed capital accumulation. Schemes such as Income-Based
Repayment and the Pay as You Earn plans usually require consolidating student loans and have largely been
designed to prevent debt burden (how much of the borrower’s monthly income has to be devoted to paying back
student loans) from becoming excessive. In order to reduce payments, income-driven repayment plans extend the
time students typically have to pay off their loans from 10 years to up to 25 years in the case of the Income Contingent Repayment plan. We suggest that this adds to the student loan problem rather than solving it. Even
before the growth in use of these types of programs, the length of time borrowers took to pay off loans was
increasing. For example,
Akers and Chingos (2014) find that the mean term of repayment in 1992 was 7.5 years; it
increased to 13.4 years by 2010 largely because of students consolidating their loans. The time it takes to pay off
loans is only likely to grow as income-driven repayment plans are ‘sold’ as a way to increase affordability.
As examples of how making minor changes to the terms of student loans will ultimately fail to address the problems
caused by their underlying structure and mere presence in the financial aid landscape, utilization of these
modifications is growing rapidly,
alongside continued increases in concerns about the consequences of student
borrowing. In 2013 these programs accounted for 6 percent of borrowers in repayment and, by 2014, nearly 11
percent of borrowers were in such a repayment modification (Delisle, 2014). Further, these programs account for
almost 22 percent of the Direct Loan portfolio in repayment (Delisle, 2014). While these programs are lauded by
many as a great way to manage loan burdens, the fact that so many borrowers require such programs should be a
warning sign that the current program is flawed. That is, if so many borrowers find their regular payment plan to be
unbearable, and in fact, such payments are officially deemed to be unbearable, one could reasonably conclude that
the U.S. has a student debt problem. This realization is even more disturbing in light of evidence that the ‘solution’
adopted to address this problem may only intensify the long-term harmful effects of student loans, while reducing
the policy momentum for more substantive reforms by easing some of the pressure exerted by overburdened
borrowers. Indeed, as Egoian’s (2013) research and others makes clear, putting off asset accumulation for 10 to 20
years has real consequences; even having to divert seven percent of one’s income to paying back loans may have a
large effect on long-term wealth accumulation, let alone the 10 to 20 percent required by income-driven repayment
plans.
From the evidence discussed in this report it appears clear to us that the student loan program exacerbates uneven
returns on a college degree. This conclusion is all the more convincing when we consider that it is not based on any
one study but a body of evidence conducted by a variety of different researchers and ranges across a number of
different outcomes (e.g., marriage, homeownership, financial distress, etc.) using a variety of different methods and
samples. However, at the same time, it is important to emphasize that as a whole, this evidence does not suggest that
higher education does not pay. Human capital is created by student debt, and graduates can leverage their human
capital into earnings and wealth accumulation potential. That promise makes these findings, which call into question
the soundness of the U.S. financial aid system, all the more alarming, since aspiring students who cannot finance
their post-secondary educations from family wealth largely have to choose between foregoing valuable educational
investments, on the one hand, or taking on potentially crippling student loans on the other. Faced with these
undesirable ‘options’, students’ fates seem largely out of their control, contrary to the American ideal of reward for
effort and ability. In the end, students with outstanding student debt still end up behind their peers whose family
asset stores or other advantages enabled human capital accumulation without significant borrowing.
