The next debt bubble: college loans
In the last few years, excessive borrowing has led to a housing-market collapse -- and now, to Standard & Poor’s downgrading of the US credit rating.
But America’s debt-fueled woes haven’t ended: The higher-education industry may be the next bubble to burst.
Moody’s rating agency recently issued a report that should be a wake-up call to every student now considering taking out large loans to pay for college.
Total student debt is at an all-time high -- and may top $1 trillion this year. Meanwhile, default rates are rising alarmingly. Skyrocketing tuition, lax lending standards and high rates of unemployment have created the perfect financial storm.
Some advice to college students: Learn from our government’s mistakes and avoid borrowing your way into a hole.
Tuition costs have more than doubled since 2000, far outpacing the inflation rate -- even surpassing the bubble-fueled growth in real-estate prices.
Tighter lending standards for auto loans and mortgages have vastly improved loan performance. Yet student-loan-default rates are getting worse, not better.
For 2008, the most recent year for which data is available, the default rate was 7 percent, up from 4.6 percent in 2005. Among students who attend for-profit institutions, the default rate is nearly 12 percent.
Despite high default rates, lenders have had little incentive to curtail the amount of money they loan to students because the federal government guarantees most student loans. Yet, for borrowers, the consequences of default are severe.
Unlike most debt, student loans are almost impossible to dispose of through bankruptcy. If students fail to repay, their tax refunds can be withheld and wages and Social Security payments can be garnished.
President Obama’s takeover of the student-loan industry last year means the government no longer backs private loans, and most students now borrow directly from the government. But unless the government improves underwriting standards, we’ll have an ever-growing portfolio of bad loans on the federal books, and all taxpayers will pay for it.
Financial advisers often refer to educational debt as “good debt” because college graduates make far more on average than nongraduates.
But not all degrees provide an equal return on investment. A degree in chemical engineering, for example, produces an average starting salary of $64,500. Someone with a degree in culinary arts, however, can expect to start out making less than $30,000 -- a salary they might get without a degree. Yet despite such differences, the government subsidizes loans as if all majors were equally valuable.
Another problem is that many students borrow money for college but never finish, and so don’t reap the financial rewards of a degree. Of those who enroll in college, more than 40 percent fail to complete their degree within six years. Among minorities and the poor, graduation rates are even lower.
Moody’s report expressed concern that many borrowers and lenders have unrealistic expectations of borrowers’ future earnings. “Unless students limit their debt burdens, choose fields of study that are in demand and successfully complete their degrees on time, they will find themselves in worse financial positions and unable to earn the projected income that justified taking out their loans in the first place,” the agency wrote.
Education has an intrinsic value beyond finding a good job and making more money. But most students enter college expecting it to pay off economically. Looking at the rising student-loan-default rate, it’s hard not to conclude that, for many students, college is failing to produce the returns they expected.
The job market, while tough for all, is even tougher for recent college grads. A study showed that among 2010 graduates, only 56 percent had managed to hold at least one job by this past spring. No wonder defaults are on the rise.
In this troubled economy, students should look for ways to reduce their borrowing, such as working a part-time job. Some may wish to lower their costs by attending community colleges for the first two years. Most should avoid for-profit colleges, where costs and default rates tend to be higher. Finally, students should carefully assess the marketability of their chosen course of study and the likelihood that they’ll be able to finish their degree.
With no lift to the job market in sight, the financial consequences of mishandling such decisions could be dire.