Will Default Rates on Student Loans See a Dramatic Increase?

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Student Loan Debt: The Next Financial Crisis?

The United States experienced the dot.com bubble in 1999 and a housing bubble in 2013. Is there a student loan bubble looming in the future? As of March 2013, the national student loan debt was $986 billion (USA Today). There are questions as to whether the current student loan situation will lead to a bubble or not; either way there is reason for concern.

Is it a Bubble?

It is tempting to predict that the nation is headed for a student loan bubble, because the characteristics of a bubble are evident. One of the characteristics of a bubble is high demand. For years a college education has been touted as the key to a better life. Accordingly, larger enrollment resulted in the increase of tuition at a rate that exceeded any other sector of the economy, including health care. The increase in tuition led to increased borrowing of money through student loans, with the total outstanding student load debt approaching one trillion. Just as in the housing bubble, student loans were made on a mass scale with little regard to the ability of the borrower to repay it.

Government legislation

Congress has been working on new legislation that addresses the rising interest rates of student loans by tying the interest rate to the yield on the 10-year Treasury note. Under this legislation current loan holders would pay 1.8 to 3.8 percentage points above what the government pays to borrow over the next 10 years. The problem is that rates would increase as the economy improves and interest rates would rise. Under this system future borrowers would be subsidizing current borrowers as the cost of borrowing would increase for future loan holders.

Students, Majors, and Schools

Just as rising interest rates and mass lending are issues for the lending side of the equations, those applying for student loans are also responsible for the rising student loan debt. Will students enter a career upon graduating that provides an earning potential large enough to make repayment? The major that students choose and the demand for that major in the marketplace are important factors in determining students’ ability to repay their loans upon graduation. Even the level of education that students desire to attain deserves careful consideration as a student who graduates with a certificate in engineering can out earn a student with a bachelor’s degree, and 30% of associate degrees earn more than a bachelor’s degree.

The selection of schools to attend also is important. For profit schools are growing in number spurred by the increase in college enrollment, which has tripled in the last 10 years. Of those students attending for profit schools, 96 percent will take out student loans, which is higher than that of nonprofit schools, as is the default rate (CBS NEWS).

Beyond choice of school and major, there is the issue of completion rate; one out of five students who attend a community or for profit college in pursuit of a bachelor’s degree will drop out before graduation. Those students who drop out lack the degree but retain their student loan debt, which normally cannot be discharged, even with bankruptcy. Students who do graduate may find entry level salaries are lower than expected.

The sky rocketing student loan debt faced by this nation poses major concerns for all of us. New student loan legislation is a temporary fix. The economy is in slow recovery, and interest rates will eventually rise. Unless this trend is reversed student loan debt may become a national crisis, whether it’s called a bubble or not.

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Marvin Ackerman enjoys contributing material on financial and legal issues such as Bankruptcy Alternatives, Financial Regulation, Taxation, Student Loans, Credit Card Debt and other important areas.