The Impact of Student Loan Debt on the Economy

The numbers from American Student Assistance are staggering. The amount of student loan debt in the U.S. is at or slightly more than $1 trillion. This debt is shared by approximately 37 million borrowers and represents an average loan balance of more than $27,000 per borrower.

Graduating from college with this much debt is clearly a strain on individuals and collectively on the U.S. economy. How much of a strain? U.S. News provided some insight.

As a direct result of student loan debt, an article published by the Federal Reserve Bank of New York and referenced by U.S. News found:

Homes

Those with student loan debt today are not homebuyers. In the past, young adults with student loan debt (college graduates) were more likely than those without debt (non-graduates) to purchase a home. Now the reverse is true. Those without student loan debt are now more likely to buy a home than those with debt.

Home buying, subsequent remodeling, and home building are all significant drivers of economic growth. When a substantial percentage of recent college graduates with student loan debt remove themselves from the home buying equation, the result is not good for the economy.

Automobiles

Federal Reserve Bank researchers discovered the same trends when it comes to car purchases as they did with homebuyers. Historically, college graduates with student loans purchased cars in greater numbers than those without loans.

Starting in 2008, the shift began and by 2012, those without student loan debt were buying cars in greater numbers than those with outstanding student loan debt.

The impact of the automobile industry on the nation’s economy cannot be overstated. Sadly, as the Federal Reserve study shows, the loss of a significant percentage of both first-time homebuyers and car buyers has a dramatic effect on the economy.

Credit Scores

Simply owing money is not the only factor affecting the willingness of recent college graduates to make large purchases. Many of those who want to buy a house or a car are unable to do so due to the negative impact their debt has on their credit scores.

The combination of stagnant wages for recent graduates along with significant debt has driven credit scores down to the point where credit either isn’t available or isn’t practical due to high interest rates.

Keep in mind all this happened at the same time banks began implementing stricter credit requirements for all borrowers. The study cited by U.S. News, for example, noted that the Federal Housing Administration raised its minimum credit score requirement to 580 with many banks requiring a FICO score as high as 640 to qualify for an FHA mortgage.

The study showed the average college graduate carrying student loan debt had a FICO score of 625. The average 25-year-old with no debt had a score of 640.

The Finer Things

As one might imagine, if the basics of independent life, a house and a car, are out of the question, so are many other things, often considered “extras.” All of these extras are part of the economy as well.

They include dining out, attending sporting events, and concerts, buying new clothes, and more. The New York Times quoted Kevin Carey, director of the Education Policy Program at the New America Foundation, a research group based in Washington, who said, “It is a new thing, a big social experiment that we’ve accidentally decided to engage in. Let’s send a whole class of people out into their professional lives with a negative net worth. Not starting at zero, but starting at a minus that is often measured in the tens of thousands of dollars. Those minus signs have psychological impact, I suspect. They might have a dollars-and-cents impact in what you can afford, too.”

Putting it All Together

The combination of a “still weak” economy, tighter credit standards, and student loan debt provide a one-two-three punch to the financial gut of many young college graduates.

Taken alone, these factors might be manageable. Together, they represent what, at times, feel like insurmountable roadblocks to success.

The feeling is real and so are the roadblocks. The New York Times report cited calculations by the Pew Research Center that the ratio of debt to income for those under the age of 35 is now 1.5 to 1. In 2001, it was 1 to 1.

In addition, according to Pew, the composition of that debt has shifted from homes to student loans. Homes have equity. Loans do not.

Will it Get Worse?

If Congress doesn’t act, the interest rate on many federal student loans will double on July 1. This falls under the heading, “If you think the impact of student loan debt on the economy is bad now, just wait.”

Some House Republicans and Senate Democrats have advanced proposals to try to hold interest rates down. The proposals are many and varied – and there is no guarantee any of them will be acceptable to a majority in Congress.

Will it Get Better?

Over time, most college graduates will be able to make up the ground they have lost. Historically, college graduates do substantially financially better than their counterparts without a college education do.

Chris G. Christopher of the forecasting firm IHS Global Insight summed it up in The New York Times report. “For an individual going to college and ending up with a lot of debt, “ Christopher said, “you’re still better off.”