Should Policy be Used to Abate Student Lending Woes?
As of March 2013, 38.6 million Americans have a combined $869.9 billion of student loan debt, which represents an increase of 16% from the same time just one year ago at $748.6 billion. Further, there are currently more than 125 million student loans outstanding, indicating the average student takes out more than three loans to cover the full cost of their education.
A combination of economic factors is driving the current student lending trends of historically high balances and record levels of delinquencies: the wave of unemployed or underemployed that are enrolling or returning to universities to gain additional training and more marketable degrees; high tuition costs require many students to secure multiple loans to cover college expenses; and graduating students with outstanding loans are entering a weak labor market, limiting their ability to repay – leading to higher numbers of loan defaults.
Credit unions that have a relationship with a member from an early age through a checking or savings account have the benefit of insight into how that member manages his or her money. Extending that relationship, credit unions can take additional steps to ensure healthy loan performance by counseling members with student loan debt on how to best manage their credit, providing financial management training and establishing the institution as a knowledgeable resource. All of these steps create opportunities to provide further financial support for the next phase of the member’s life.
A student loan is unique in the lending industry in that a student is presumably using the funds to subsidize an education that, presumably, will increase his or her future earnings potential. However, at the time of underwriting, the student’s income is limited, complicating the lender’s ability to gauge the borrower’s actual ability to repay.
Unlike automobile, home and credit card lending, the collateral for a student loan is the investment into the human capital itself, which cannot be repossessed later if a loan goes into default. For this reason, student loan debt is not discharged in bankruptcy except in rare cases, such as for a severe and permanent disability.
Recent regulations regarding ability to pay have made it very challenging for individuals under the age of 21 to open credit in their own name if they are not employed and have tightened up on extending credit card offers with incentives such as free merchandise due to consumer protection concerns. As a result, the standard rules of credit, collateral and capacity underwriting that apply for other credit tradelines do not apply in the same way to student loans.
Private student loan providers typically use stronger underwriting criteria than those demanded by federal student loan programs, and students can often get a better rate if their parents are co-signers on the loans. These loans perform better on average as a result, but are nonetheless affected by the currently weak labor market affecting graduating students.
In addition to these underwriting challenges, there are three other primary issues to consider in relation to the nation’s current student loan woes. First, the basic structure of a student loan has remained unchanged for many years. While in school, a student is typically not required to pay interest on a loan. Upon graduation, the loans fully amortize after a short deferral period, which means students with multiple loans, higher debt and limited employment opportunities face considerably higher monthly payments.
Nine percent of borrowers with student loans owe between $50,000 and $100,000, and 3.7% of borrowers owe more than $100,000. Their fully amortized payments often exceed $500 or even $1,000 per month, often unaffordable for someone starting out in their career, while unemployed college graduates leveraging deferment periods see their loan balances grow due to accruing interest.
Policy discussions around how to improve the performance of student loans have suggested that altering the amortization schedule of the loans might help, with near-interest-only payments early on and accelerating principle payments as the borrower’s career matures.
Second, there is a radical change in the longstanding belief that going to college, regardless of major, will prepare a young person for greater career success. In reality, the market does not treat all majors equally and students are finally taking notice. Some majors supply graduates at a level that exceeds market demand while other skills are in high demand and experiencing a shortage, yet the pricing for tuition and for interest rates on student loans across all majors remains equal.
While underwriting or setting interest rates based on what someone wants to be when they grow up may not be feasible, there is mounting pressure to hold schools accountable for the marketability of their degrees. For-profit universities are facing the greatest scrutiny, but traditional colleges and universities also face challenges – whether from potential consumer protection regulators, or the tort bar.
Third, there are great shortages of certain skills in the workforce. One way to increase supply of workers with these in-demand skills is the concept of loan forgiveness tied to public service. Those who graduate with a certain degree such as a teacher’s certification or a medical degree can gain special compensation by serving in designated communities for a set amount of time. The public service is then used to forgive part or all of the debt while using the student’s skills to benefit an area in need.
Some employers also offer student loan forgiveness benefits after a certain length of service has been attained in addition to tuition reimbursement benefits that they may offer employees currently enrolled in part-time college training. While these debt forgiveness benefits are not widely offered, they can give an employer an edge in not only recruiting top talent, but also retaining it.
This policy idea has many benefits to the student as providing experience, debt reduction, and a better credit rating, as well as benefits to taxpayers or employers, higher-skilled workers at relatively low cost, while improving lender balance sheets. Such programs already exist; the question is whether they can be expanded sufficiently to make a dent in the debt and skills-mismatch problems.
The hard truth is that student loan delinquencies will likely continue to increase until the labor markets significantly improve and mitigating measures are put into place. Offering credit counseling, financial management training and outreach to members with student loans may give them a boost in getting a handle on these debt payments.
Regardless, the fact remains: students entering the economy with historically high levels of student loan debt limits their capacity and desire to acquire other forms of consumer debt and move on with their lives – buying cars, homes, forming families. Long term, more consumers with less buying power will result in stifled economic growth in what could be an otherwise booming period.
Amy Crews Cutts is chief economist for Equifax.
703-714-6388 or Amy.Cutts@Equifax.com