Brian Rock, New Leaders Council New Jersey
Part one of The New Leaders series A Trillion Dollar Anchor: The Weight of Student Loan Debt on the Millennial Generation
There’s no question that the cost of college has skyrocketed and that millennials are taking out unprecedented levels of debt to complete college.
Once upon a time, government picked up a large portion of the cost of college, but in the last few decades those costs have been pushed on to students and their families. In the decade since the Great Recession, this trend has only intensified. Whatever metric you look at, it’s the same story: The aggregate amount of debt is up — now over $1.3 trillion. The number of students taking out loans is up — 70 percent of students now borrow money to help pay for college. The average debt is up too — now well over $30,000.
The amount of borrowers owing over $100,000 is up to five percent — an outlier today, but a very real and growing group.
If college is simply an investment in your future, that’s not necessarily a bad thing. After all, a college education yields higher lifetime earnings. But the major shift lies in who is making that investment.
But if you’re not a millennial, why should you care?
Because the result is a generation unduly saddled with debt and ultimately less able to be drivers of the economy than their predecessors.
The Nation’s Shifting Debt Portfolio
Let’s put this change in the nation’s debt situation in perspective. Consumer debt is comprised of five main categories: home, auto, credit card, student, and other debt. In 2003, student loan debt was the smallest category (3.1 percent). By 2015, student loan debt had taken the number two spot, representing 10.4 percent of the nation’s consumer debt.
The contrast is even more stark if you zoom in on millennials. Between 2003 and 2015, there was little difference in average debt per capita among 30 year olds — it hovered around $40,000. But the average amount of student loan debt held by a 30-year-old ballooned from $4,000 in 2003 to almost $11,000 in 2015. That’s 27 percent of all debt held by that age cohort. Over the same time period, the average amount of home and credit card debt held by 30-year-olds fell by a third (see the data from the New York Fed Consumer Credit Panel).
Herein lies the dilemma: A person has only so much capacity for borrowing. If one category of debt — i.e. student loans — is taking up an increasing share of that capacity, other categories are going to be displaced. In the long term, this will alter the life trajectory of millennials who take on this debt and it will eventually have an impact on an economy driven by consumer spending.
There are three areas in particular where we can already see these effects taking shape — housing, business formation, and retirement savings.
Lower Homeownership Among Millennials and Among Borrowers
There is a broader trend towards lower homeownership since the Great Recession, but this is particularly true for millennials. For those under age 30, homeownership rates have steadily declined and bottomed out at 25 percent in 2015. But there’s also plenty of evidence that student loan debt is a factor in determining whether and when a person can purchase a home.
While much of this research is limited to identifying correlations, there are several convincing explanations for how student loan debt prevents or delays a person from purchasing a home. This debt can directly obstruct homeownership by increasing a person’s debt to income ratio, or by lowering a person’s credit score due to late payments or defaults. It can also indirectly impede homeownership by making it harder to save money for a down payment.
In a survey of millennial student loan borrowers, nearly a quarter of respondents who didn’t own a home reported that they had been denied for a mortgage. They wanted to buy a home, but they couldn’t. The most common reason cited was a high debt to income ratio. The second most common reason was not having a large enough down payment.
For other students, late payments and defaults mean a low credit score — and the resulting inability to get a mortgage. Five year default rates increased from 19 percent for the 2006 cohort to 28 percent for the 2011 cohort. The problem is more severe for high balance borrowers. Those with over $100,000 in loans had a relatively low default rate of 6 percent in 2006 and this skyrocketed to 21 percent in 2011. That’s particularly troubling, given that the share of borrowers who owe six figures is increasing.
Meanwhile, it’s no surprise that late payments equal lower credit scores, and that late payments also correlate to lower home ownership rates. Data from the Fed showed that borrowers who paid on time had an average credit score of 744, while those who had defaulted had an average credit score of 549. Defaults represented 31 percent of the cohort. (See the slidedeck from the New York Fed for the full picture).
Student loan debt can place a lot of barriers to home ownership. The same survey of borrowers indicated that on average they had delayed their choice to buy a house by seven years.
The old joke about millennials is that we’re a generation that “failed to launch”, but many of us are not living at home or with roommates by choice. It’s hard to launch when you’re tied down by an anchor.
Impact of Student Loan Debt on New Business Formation
While the housing market is one piece of the story, student loan debt is negatively impacting the ability to form new businesses as well.
A study by the Federal Reserve Bank of Philadelphia examined this equally disturbing trend.
The logic goes like this. Small businesses are often started using some form of personal debt as a funding mechanism, whether from credit card debt or a home equity loan. Excessive student loan debt makes these other forms of credit less available. Simultaneously, borrowers with significant loan payments may be less likely to risk starting a business, as they need a steady paycheck to avoid default.
The study examined student loan debt at the county level, compared it to new businesses formed in those counties, and found that an increase in student loan debt correlated with an underperformance in the number of new small businesses created.
The birth of new small businesses plays a crucial role in creating jobs and propelling economic growth. As the student debt crisis deepens, more and more millennials will leave college unable to join the ranks of entrepreneurs.
And the rest of us are left with fewer new jobs and a weaker economy.
Impact of Student Loan Debt on Retirement Security
Meanwhile, a longer term question for the country is whether or not people are ready to retire. With traditional pension plans fading away into obscurity, retirement savings is more important than ever. If student loan debt is impeding retirement savings, then we may be facing a bigger problem thirty or forty years down the road.
The Center for Retirement Research at Boston College produced a study on the potential effect of student loan debt on retirement security. They found that those who finished college with debt had a modest increase in their risk of not having enough income in retirement. But there was an alarmingly large difference when they looked at those who did not finish college but still accrued debt.
And this highlights a whole other problem. College enrollments are increasing and more students than ever are attending college. But a significant number of those students aren’t completing college.
Instead, they leave college with a small amount of debt and no degree. Their earnings aren’t much higher than someone who never attended college, so they have no return on their investment to pay for those loans. As a result, this group has the highest default rate amongst student loan borrowers.
This Is a Problem for All of Us
College may remain a good investment for those who finish and graduate with a modest amount of debt, but large number of millennials don’t fit that description, and instead are struggling with a growing mountain of debt.
They’re delaying home purchases or avoiding them completely. They’re missing payments and defaulting on their loans. They’re not starting businesses or saving for their retirement.
This isn’t just a problem for the millennial generation — it’s a problem for us all. Buying homes, launching business, and saving for retirement are all critical for a healthy economy. The nation’s economic engine can’t be firing on all cylinders if its largest generation is sitting on the sidelines.
It’s time we start looking at how to dig ourselves out of this mess before it gets any worse. Join the New Leader over the next few weeks as we explore the topic of student debt from a number of different angles. We’ll trace the history of how we got here, analyze some current policy proposals, and explore some potential solutions.
Brian Rock is a social studies teacher in East Orange, New Jersey and he writes about civics education at The Civic Educator. He is the Vice President of his local teachers union and he is the Institute Co-chair for NLC New Jersey.