Promoting access to higher education is a laudable goal, the desirability of which is widely appreciated. However, the current student loan system in the United States is broken and is now impeding the ability of the millennial generation to claim its piece of the American dream.
The Federal Reserve Bank of New York recently released its quarterly report on household debt patterns, and the results clearly highlight the increasingly problematic surge in student loans. As of December 2014, student loan debt reached an all-time record of $1.16 trillion. In contrast, auto loans in the U.S. totaled about $1 trillion, and total credit card debt was just $700 billion. Today there is roughly one dollar in college loans for every $10 in total household debt including mortgage loans. And student loans are growing faster than any other class of borrowing, swelling by nearly as much as home mortgages in the fourth quarter of 2014.
In fact, the rate of growth is staggering. According to Fed data, the total outstanding balance of student loans has increased from $240 billion in 2003, a compound growth rate of 14 percent per year. Contrast this with the annualized increase in public 4-year college costs including room and board of just over 5 percent per year, and it is clear that something doesn't add up.
The picture becomes even darker when delinquency statistics are included. In America on the whole, 4.3 percent of household debt is more than 90 days late, and mortgage debt runs around 3.1 percent past due. Meanwhile, 11.3 percent of school loans are delinquent by at least 3 months, while over 17 percent of all borrowers are seriously behind. And the problem continues to worsen.
Many analysts believe that we are on the cusp of an even direr situation, and that the burden from over-borrowing in the past five years is just now being felt. When the New York Fed looked at the class of students that left school in 2009, they highlighted the magnitude of the economic drag on the millennial generation. Over half of all borrowers in the 2009 cohort are either delinquent, in default or in a deferral plan that is adding to their loan balance. This is the canary in the coal mine.
The upshot is an inability of young borrowers to leave home and strike out on their own as their parents did. In a press release accompanying the recent report, the New York Fed stated that "student loan delinquency and repayment problems appear to be reducing borrowers' ability to form their own households."
More confirmation comes from a 2014 study conducted by real estate advisory firm John Burns Consulting. The paper looked at the impact of college loan balances on home sales, and the results are not encouraging. They found that 5.9 million households under age 40 have at least $250 in monthly student loan payments. That translates into 414,000 home sales that did not occur because potential home buyers were over-indebted. The study estimated that every $250 in monthly loan payments reduced home buying power by $44,000. That cost the economy $83 billion in lost home sales in 2014.
The recent data suggest that the problem is worsening. Federal student loans are made largely without consideration of the likelihood of repayment or potential future income. It is questionable whether $60,000 in indebtedness from an Ivy League school makes sense to obtain a degree in social work. Clearly a worthy pursuit, but a financial death sentence. And now the drag on the broader economy is manifesting itself as well.
Christopher A. Hopkins, CFA, is vice president and portfolio manager for Barnett & Co.