Is student debt really a problem?

Drowning in debt?
Drowning in debt?
Image: Reuters/Andrew Burton
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Student debt in the US is worth a whopping $1.5 trillion. Graduates are so burdened with debt, according to reports, that they aren’t buying homes or getting married. Even grandparents are burdened by student loans, having borrowed on their grandkids’ behalf.

It is no wonder, then, that US presidential candidate Elizabeth Warren has promised to wipe out student debt for three-quarters of all borrowers, as well as make public college free to attend. Her plan to forgive loans will cost more than $600 billion, on top of the cost of free college.

In a world of limited resources, it’s worth asking: is student debt really an urgent problem that’s weighing down the economy?

Why student loans are special

Student debt is special, but not because of its size. Americans have $1.3 trillion in auto loans, which is arguably a worse kind of debt than the education-related kind.

Education is an asset that appreciates over time. A degree often does not mean higher earnings right out of college, but graduates’ earnings tend to rise faster over the course of their lifetimes. If you are going to take a loan out to fund an investment, education is probably the best bet you can make. A car depreciates the second you drive it off the lot, and keeps falling in value. It could be argued that there’s an auto-loan crisis that’s nearly as big, and more dangerous.

Of course, student loans tend to be larger and more onerous than car loans. But the largest loans are usually held by people who went to graduate school, who tend to be higher earners. There is, in fact, a negative correlation between the size of a loan and the odds of default. The average loan balance of someone in default is $15,000, compared with an average balance of $26,000 for the typical borrower in good standing. This is because people with bigger loan balances have more education and are often paid more; they can afford to keep up with their payments.

Low earnings is why young people don’t own homes, not debt itself. Home ownership has not declined among Americans with a college education, but it has for people without a degree. This suggests student debt is not the most pressing problem; it’s low earnings among people who don’t graduate from college.

That doesn’t mean that student loans aren’t a problem, especially for students from low-income families who take on debt to finance a degree they don’t finish or is not worth much (which it might be, if its from a for-profit institution). Many of these borrowers in default. Their debts are crushing because their education did not increase their earnings. Defaulting destroys their credit and hampers their lives.

Helping these borrowers does not require bailing-out higher earners too. A better solution is targeting debt relief and using resources to help students from low-income families thrive in college, by offering them more counseling, financial aid, and academic support.

We should do something

Student loans are also problematic because they contribute to the rising cost of tuition, which has ballooned well beyond inflation and become a growing burden for many families. Government loan guarantees and subsidies make it easy to take out debt, making students less price sensitive. This does not, however, require taxpayers to foot the bill for everyone’s tuition as a fix.

A better alternative is income-based debt payments, where students pay based on what they earn. If universities are paid based on student performance, they will need to become more price sensitive and have an incentive to lower costs.

Student debt is a pressing problem, but not such a huge, urgent one that it requires a blanket bail-out for high-earning Americans. It would be a better use of tax money to target the most vulnerable and better align the incentives of universities with the students they serve.