Why The Student Loan Bubble Won’t Burst
While recent news of a booming economy and low unemployment might make it look like things are on the up and up, the financial outlook for today’s college students and recent graduates is still pretty bleak.
These new developments haven’t lead to higher wages for graduates already struggling to pay down massive debt, let alone ease the minds of current students who will soon be on the hook for six-figure student loans.
In 2018, student loan debt in the United States hit a whopping $1.5 trillion, making it the second-largest consumer debt segment in the country after mortgages, according to the Federal Reserve. And the number keeps growing.
What’s a bubble, anyway?
There’s been a lot of talk about the student debt crisis becoming a bubble, but first, let’s define what a “bubble” means. Experts generally agree that a bubble is created when something rapidly increases in price over a relatively short time span.
In addition to the overvaluing of a particular asset, an economic bubble has a few other features:
- Overly optimistic speculation: People assume that the price of the asset will always continue to rise.
- Buying on credit: People borrow money to buy the asset.
- FOMO: People see other people buying this asset and they don’t want to miss out on the opportunity, so they buy it themselves.
When we look at the student loan debt crisis, we can see it has a lot of the features of an economic bubble.
The cost of tuition at both private and public institutions is reaching an all-time high, and students are taking out loans at unprecedented rates to cover the cost. In the last 10 years alone, average tuition and fee prices have increased by 36% at public four-year institutions and 26% at private four-year colleges.
And college isn’t just getting more expensive – the loans students are taking out to pay for college are getting more expensive too.
In 2018, undergraduate interest loan rates jumped to 5 percent – the highest rate since 2009 and students seeking graduate and professional degrees now face a 6.6 percent interest rate, according to the U.S. Department of Education.
This double whammy of rising tuition and borrowing costs doesn’t bode well for students paying off loans. The total US student loan debt has grown by almost 157 percent over the last 11 years. In comparison, auto loan debt has only grown by 52 percent while mortgage and credit card debt actually fell by about 1 percent, according to Bloomberg.
While student debt would be more manageable if students were getting well-paying jobs post-graduation, this isn’t the case. New grad starting salaries have barely kept pace with inflation and the gap between students’ debt load and their earning potential continues to widen.
For-profit college graduates are in the worst shape. For-profit colleges pitched themselves as a way out of low-paying jobs, but many of those degrees ultimately proved useless. In fact, many for-profit college graduates are earning less than minimum wage. If you’re a minority graduate, discrimination in the labor market can make matters even worse.
Now, the situation has reached a crisis point where many graduates literally can’t afford to pay back their loans. Student loan debt currently has the highest 90+ day delinquency rate of all household debt. Ten percent of student loan borrowers are at least 90 days delinquent (mortgages and auto loans have a 1.1 percent and 4 percent delinquency rate, respectively).
Why it’s not going anywhere, anytime soon
If you’re hoping for this student loan bubble to pop so you can get cheap tuition, you might be waiting a long time. The student debt crisis shares a lot of similarities with the 2008 mortgage crisis, but there are some key differences that would prevent this bubble from collapsing in the same way.
For example, with the housing crisis, when a borrower couldn’t pay their mortgage, the bank foreclosed on their house. The bank then sold these assets, even at a loss, causing the bubble to pop. Even though the economic effects are devastating, this kind of deflation can happen relatively quickly.
In comparison, student loan debt is backed by the borrower’s future earnings. As long as there is earning potential, the student loan bubble can keep growing. Plus, there is no incentive for colleges to lower the cost of admission. And given that policymakers allow virtually limitless student loan borrowing to cover the costs, the debt load can continue to grow regardless of students’ ability to pay it back.
What happens next
As young adults struggle to pay back their loans, they’re forced to make financial trade-offs that have wide-reaching effects on the economy. They can’t buy houses and cars, start businesses and families, save, or invest, and this will negatively impact a number of different industries. Experts predict that the bubble will eventually unwind, this will happen over the course of decades.
So what can students and new grads do in the meantime? To start, be proactive when researching different repayment plans and take advantage of income-based plans, if possible. Also, remember that loans aren’t the only way to finance your education. Merit-based awards, tuition discounts, scholarships, and bursaries are all great ways to cover the cost of school without going into debt.
Student loans can’t always be avoided. But at the end of the day, your top priority should be to find a school you can afford. As a rule of thumb, you should never take out more student loan debt than you will earn in your first year’s salary. So if you expect to earn $50,000 right out of college, you shouldn’t have more than $50,000 in student loans total.
This might mean you’ll have to adjust your expectations around studying out-of-state or stick to a tight budget while you’re in school. No matter what you decide to do, remember that the most important thing you can do today is keep your debt at a manageable level so you’re not struggling financially later on.