Student Loan Debt: Feverish Anecdotes Trump the Facts

Congress is currently debating new legislation on student loan debt that would seek to keep interest rates on future loans from rising. As the law stands, the interest rate on student loans is set by the government at a significantly below market rate, and if Congress does not act the rate on the government-subsidized category of student loans will increase from 3.4% per year to 6.8%. Both political parties want to stop this from happening, but they cannot seem to agree on what should happen instead.

Perhaps it would help if Congress, and those clamoring for Congressional action, had a few more facts about student loans. Sob stories and summary statistics designed to convince people there is a crisis are dominating the debate on this topic. What we need is a more careful look at the underlying facts.

The total of student loan debt in the U.S. is now up to about $1 trillion, a sum that has staggered many people and caused lots of policy makers to think we have a crisis on our hands. Having doubled in about the last six years, student loan debt now exceeds both credit card debt and car loans in terms of the total outstanding. By 2020, student loan debt is on pace to exceed credit card debt and car loan debt combined.

However, student loan debt differs from credit card and auto loan debt in that the money spent was invested (hopefully) in human capital formation and will pay dividends in the form of higher earnings over the rest of the borrower's working life. People investing in education instead of cars is not necessarily a bad thing.
Plus, for all the numbers about the enormous and rapidly growing total student loan debt, and for all the news stories about sympathetic students burdened with huge student loan balances and poor career prospects, most of this debt has been incurred very responsibly.

According to the Federal Reserve Bank of New York, the median student loan debt balance is about $13,000 (the median means that half of borrowers owe more than that and half owe less). Thus, for half or more of all borrowers, those who have borrowed small sums to help themselves complete college, interest rates do not have a huge impact. If you owe $10,000 in student loans, an extra 3% in interest means a $25 per month increase in payments. Perhaps not fun, but not likely a financial disaster for many people.

Only a small percentage of borrowers have very large loan balances. About eleven percent or roughly four million people owe $50,000 or more in student loans. Around one million people owe $100,000 or more. On loan balances of these sizes, a doubling of interest rates would mean much higher payments and would add several hundred dollars a month to required payments. While changes to the program impact new loans, not existing ones, clearly there is a small group of people for whom interest rate changes matter.

Given the maximum amounts one is allowed to borrow in federally-guaranteed student loans, a large percentage of those with large balances are likely to be people who incurred the debt going to graduate school, especially law school and medical school. Thus, a significant number of these high-debt load people probably have the income-earning potential to handle their loan balances.

Taken together, these data suggest that for all the hype, media coverage, and political debate, the issue of burdensome student loan debt is confined to a group of probably one to two million people. This is hardly an enormous number of people, so perhaps we should all calm down for a minute and worry about this small group of people rather than the approximately 35 million who appear to be using the student loan program responsibly.

For the 35 million or so fiscally responsible users, the debate is simply about whether the federal government should charge a subsidized rate of interest, a market-based rate of interest, or perhaps even a profitable rate of interest. As a free-market-leaning person, I would prefer the market-based rate of interest (which has been included in several of the proposals on Capitol Hill), but the reality is that the final choice makes little difference in terms of financial impact on the borrowers or the federal budget.

At the risk of mischaracterizing some of the people in the one to two million person group with large loan balances, the pool of people for whom serious thought needs to be given vis-à-vis student loans is mostly people who borrowed heavily for expensive undergraduate educations in fields of study that have limited earning potential. The news stories have been full of these sorts of people who appear to have no means of ever paying off their student loan debt.

Rather than worrying about the interest rate, the politicians should be wondering why there are so many fewer safeguards and consumer protections for student loans than, for example, mortgages, particularly since our recent real estate bubble burst. Potential student loan borrowers should be given more information on what future payments will be and how student loans cannot be discharged in a bankruptcy (you are stuck with them for life).

Given that the federal government is meddling in a market with very little demonstration of why such meddling is needed, perhaps the government should establish a much lower cap on the total amount of student loan debt unless the borrower is studying in a field that has a demonstrated national need or a proven earning potential. That is, the government might cap federal student loan debt at $30,000 or $50,000 unless you are actually likely to be able to repay the loans.

Currently, repayment probability is not a factor in how much you can borrow. You must prove financial need and be attending an eligible school. That's it. Nowhere else can you borrow $100,000 without somebody checking on the chances that you will be able to repay the money you are borrowing.

It might make sense to offer generous loan terms to people studying to be nurses, since there is a national shortage of nurses. Engineers and doctors are good bets to pay off their loans; so again, lending more money might make sense. However, in many fields of study with lower income potential and no shortage of qualified workers, it is unclear what national interest is being served and also whether the government is helping or hurting the borrower involved when excessive loans are made to students who are unlikely to be able to pay them off.

Research on student work hours and academic success is somewhat mixed, but it appears that working part-time (less than 30 hours per week) does not negatively impact student grades or graduation rates. Perhaps more students should be encouraged to work their way through college or more evenly mix work and loans so as to avoid taking on overwhelming debt loads.

Rather than worrying about the interest rate charged, Congress should focus on eligibility requirements and limitations on total indebtedness. Enabling students to become burdened with debt without a career that can support the required payments is not good government, whatever interest rate you charge for the service.