In the media

The Real Student Loan Crisis

Robert Hiltonsmith

A month has passed since Congress allowed interest rates on federal student loans to double for some borrowers, increasing the cost of their college educations by as much as $4,500. While the debate continues to focus on the interest rate for future borrowers, it is ignoring the larger problem with student debt: the more than $1 trillion that had already been borrowed before the interest rate debate. This existing debt will continue to drag down borrowers’ financial security, which in turn drags down the entire economy. By how much? Demos, the public policy group where I work, has just released a study that estimates the economic impact of the existing student debt burden, and finds that it may cost the country more than $4 trillion in lost economic activity.

This economic drag happens because student loan payments take a significant bite out of many borrowers’ incomes, causing them to delay or forego important purchases or investments. A recent study by the American Institute of CPAs found that 75 percent of student debtors had made personal or financial sacrifices because of their student loan payments. Forty-one percent have postponed contributions to retirement plans, 40 percent have delayed car purchases, and 29 percent have put off buying a house. The effects of delaying making these crucial investments early in borrowers’ lives, in turn, are magnified because of the amount that the lost home equity and investment returns would have compounded over their entire working lifetimes.

Our study tries to estimate just how much delaying saving for retirement or purchasing a home will cost borrowers over their lifetimes. We use data from the Federal Reserve’s 2010 Survey of Consumer Finances (SCF) to determine the average salary, retirement savings, and liquid savings of an average, young, dual-headed, college-educated household both with and without education debt. We then project their salary and assets over a lifetime using generally-accepted values for salary growth, savings rates, investment returns, etc. We reduce the savings of the indebted household by their monthly student loan payment while they are repaying their loan, and observe the difference in net worth between the debt-free and indebted households as they approach retirement.

The model finds that a dual-headed, college educated household that graduates with an average amount of debt ($53,000) will lose more than $200,000 in retirement savings and home equity from paying off their student loans, compared to a similarly educated household without student debt. Nearly two-thirds of this lost wealth is due to the indebted household’s lower retirement savings while paying off their student loans, while more than a third is from lower home equity. (Our model does not factor in any reduction in spending that the couple makes aside from what they spend on a home and retirement savings.) The lower home equity was primarily due to the finding, calculated from the SCF data, that indebted households bought less expensive houses than similar debt-free households. They also put less money down and paid a higher interest rate. These lost returns and appreciation on the foregone retirement savings and home equity are magnified because they occur so early in borrowers’ lives. And this is exactly why I argue that the existing student debt burden already weighing on nearly 40 million Americans is the greater crisis: because student debt causes borrowers to delay making investments at the very time when making those investments is so crucial to their future financial security.

Read the report: At What Cost? How Student Debt Reduces Lifetime Wealth