There’s been a lot of hype around the student loan bubble — the fact that borrowing through student loans has reached over $1.2 trillion. That’s an insane number. The total amount of U.S. debt outstanding is $17.5 trillion. To add some food for thought, there is roughly $13.5 trillion in mortgage debt in the United States.
The bottom line is that student loan debt is climbing. But are we in a bubble? And will the bubble pop anytime soon? If it does, what is that going to look like?
The Brief History of Student Loans
Student loans were first created in 1958 as part of the National Defense Education Act. This was during the Cold War, and it was important for national defense to have students going to college and getting advanced degrees. Think of all the students that went to school and helped with the space program and other projects. It was a really smart idea at the time.
However, the current system was really started in 1990, with a subsidy for loans and a guarantee for banks. In 1993, we started getting loans directly lent from the government. Until 2008, these direct loans accounted for around 25% of all loans issued — the rest were private loans or guaranteed loans issued by companies like Sallie Mae.
In 2010, the change was made to have all direct loans issued by the government. This meant that the government owned all Federal loans, and there were no more middlemen that issued loans with a government guarantee. However, private loans still exist.
What the Current Student Loan Bubble Looks Like
It’s important to look at the history of student loan debt to really understand what this bubble looks like.
Now, let’s look at today. We already know that there is $1.2 trillion of student loan debt out there. That breaks down to an average of $29,400 per student.
If all of these were new loans issued since 2010, the student would be paying $338 per month after graduation. This is using the basic 10-year standard repayment plan and current 6.8% interest rates.
Given that the average starting salary for the class of 2013 was $45,327, the average graduate would be paying almost 9% of their salary per year towards getting rid of their student loan debt. This is where the real problem lies.
The current student loan bubble isn’t really a bubble, it’s more like a leech on students and the economy. The reason? Unlike the housing crisis, student loans will always be paid back — it’s the system the government created. Since the government owns the loans, they can easily garnish wages, take your Social Security, and more. So, there isn’t a question about repayment. But what does happen is that this leeches earnings from borrowers — essentially putting a parachute behind the car that is the U.S. economy, just dragging it down.
How the Student Loan Bubble Will Pop
Since there is very little repayment risk with student loans, how will the student loan bubble pop? It’s going to hit other areas of the economy that millennials should be making big impacts in.
For example, graduates are going to be forced to be renters longer since they won’t have the income or debt ratios to qualify for a mortgage. This will drag down the economy, because homebuying drives other areas of consumer spending like consumer goods, home improvement, and more. Millennials are going to have to wait until they get their debt under control, or increase their income, which will take several years after graduation.
Other big-ticket — and even small-ticket — items will have to be put on hold by recent graduates as well. All of these factors will just drag the economy, especially as the current spenders (baby boomers) start leaving the mainstream economy and lower their spending in retirement.
How else do you see the student loan bubble popping?