The Big Idea
Assessing the student loan burden
Stephen Stanley | September 8, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The federal government suspended repayments and interest accrual for all federal student loans in April 2020, part of an extensive effort to support the economy as pandemic broke out. The Biden administration repeatedly extended that suspension over the past three years, but Congress finally voted in May to resume interest accrual as of September 1 and loan repayments on October 1. Although the impact of renewed accrual and repayment may not fall equally across all households, the impact on the broad economy should be limited.
Scale of the student loan program
In 2010, as part of the Obamacare health reform package, the federal government took over the bulk of the student loan program. Before that, private financial institutions distributed student loans, though most of them were guaranteed by the federal government. At the time, the CBO scored this step as a money saver for the federal government, reasoning that “eliminating the middleman” would create cost savings. Thus, the federalization of the student loan program was enacted, at least in part, as a “pay-for” for the health care reform package.
Since 2010, the scale of the student loan program has surged. Student loan debt roughly doubled from about three quarters of a trillion dollars in 2010 to over $1.5 trillion by 2019 and has been broadly steady since then, standing at $1.57 trillion on June 30, according to the New York Fed’s latest quarterly report on household debt and credit.
According to the New York Fed’s data, compiled jointly with Equifax, there were 43.3 million student loan borrowers as of the end of 2021. However, loan balances are far from evenly distributed. Over 7 million borrowers, roughly one-sixth of the total, owe less than $5,000 on their loans. Nearly that many owe between $5,000 and $10,000. Thus, almost one-third of student loan borrowers owe less than $10,000. Another 11.5 million owe between $10,000 and $25,000. On the other extreme, about 9 million borrowers owe more than $50,000, roughly 3.6% of the total U.S. population aged 20 and over, or 1 out of every 28 people.
Terms of repayment vary widely, so estimates are necessarily rough. Just to start, if I feed a $1.6 trillion loan into a standard mortgage payment calculator assuming a 15-year fixed loan and a 4% interest rate, the monthly payment associated with that burden would be about $12 billion. Dividing by the 43.5 million borrowers yields an average of $276 per borrower per month. This back-of-the-envelope calculation is not too far off, as the Federal Reserve Board reported that in 2019, “of those who were making payments, the typical required monthly payment was between $200 and $299 per month.”
Realistically, the burden would be lower for several reasons. First, the Department of Education has created a number of income-based repayment options that allow borrowers to pay back their debt more slowly with a chance for partial forgiveness after a specified number of years. In fact, these programs are much more prevalent today, and the Administration has announced its intentions to widen their eligibility further going forward. The GAO estimated last year that 47% of loan dollars in the Direct Loan program was in some form of alternative repayment plan.
Second, as you may recall, prior to the pandemic, the federal government had a substantial non-payment problem. Despite the fact that student loans hold a special legal status—they are not allowed to be expunged even in the case of bankruptcy—the New York Fed data show that in 2019, $128 billion in student loans were in default and another $67 billion were over 90 days delinquent. Combined, that amounted to 13% of total loan balances that were not being serviced prior to the pandemic moratorium. It seems reasonable to presume that non-payment will return to a similar proportion of loans as before the pandemic. That factor alone reduces the back-of-the-envelope estimated repayment burden by nearly $2 billion per month to just over $10 billion.
Actual payment history
The Daily Treasury Statement offers a historical record of Department of Education receipts, a rough proxy for actual loan payments. In fiscal year 2019, the last full year prior to the Covid moratorium, receipts totaled $69 billion for the 12 months, or $5.8 billion a month. In the final months before the moratorium went into place, payments were averaging between $6 and $7 billion a month.
During the pandemic, borrowers were free to make partial or full payments even though they were not required to do so, and some consistently did. In fiscal year 2021, the first full year after the implementation of the moratorium, payments totaled $31 billion, or $2.6 billion per month. In fiscal year 2022, the corresponding figures were $28.4 billion, or $2.4 billion per month. More recently, the pace of payments slid further, totaling $11 billion, or $1.2 billion per month, in the nine months ended June 2023. I suspect that a number of borrowers decided to stop making payments once the Administration announced its sweeping loan forgiveness program in August 2022.
Of course, at the end of June, the Supreme Court struck down the loan forgiveness program. Between that development and the recognition that payments were going to be required soon, borrowers have sharply altered their behavior in recent months. In July, Department of Education receipts increased to $2.1 billion, and in August they surged to $6.4 billion, not far from the pre-COVID pace.
Thus, it appears that the impact of the resumption of student loan servicing began in earnest in August. In fact, the incremental drag in October, when payments are required, seems likely to be smaller than the marginal headwind created by the tripling of payments in August.
The final step in this discussion is to translate the student loan burden figures into an economic growth impact. First, to keep everything consistent, all figures should be annualized. For example, the back-of-the-envelope $12 billion monthly servicing burden that we started with above works out to $144 annualized.
However, what we care about is not the gross servicing burden but the difference between what people were paying before the moratorium ended and what they will pay after it expires. The payments in the nine months through June work out to about a $15 billion annual pace. That seems like an extremely conservative baseline. we could use the average over the past three years, for example, which would be closer to $25 billion annualized.
I think it is plausible to assume that payments later this year will rise to a level modestly higher than what we were seeing just before the moratorium, let’s say $7 billion per month, or $84 billion annualized.
The difference between pre- and post-moratorium payment rates would then work out to about $70 billion annualized, which strikes me as a conservative, high estimate of the marginal drag.
Of course, households have two basic choices. They can make these payments by dipping into savings (or adding to debt by, for example, maintaining other spending steady and charging more to credit cards) or by cutting consumption, or any point between the two extremes.
Nominal disposable income amounted to roughly $20 trillion annualized in July. If we subtract $70 billion from personal savings, the savings rate in July would have been three tenths of a percentage point lower, at 3.2% instead of the actual result of 3.5%. Thus, if households chose to dip into savings to pay the entire marginal increase in obligations, which, admittedly, may not be an option for all affected households, the impact on savings would be modest.
On the other extreme, if households cut back on other spending on a one-for-one basis, then the July personal consumption expenditures figure would have been $19.19 trillion instead of $19.26 trillion, a 0.4% drag. However, the way that annualizing works, if we have a one-time step down like this, the impact is concentrated in a single quarter. In this case, the immediate result would be a roughly 1.6 percentage point annualized drag in the fourth quarter and then no further impact in future quarters, averaging out to 0.4% over the course of a year. Again, this would be noticeable but not a game-changer for the economy (and, most importantly, not a drag on growth for more than a quarter or two).
I would offer three qualifying caveats to these back-of-the-envelope calculations. First, as noted above, the magnitudes that I used are likely a high end estimate of the marginal impact of the end of the student loan moratorium. Second, it is safe to assume that households will split their adjustments between dissavings and less spending. Thus, a more realistic estimate of the marginal impact on consumer spending and therefore on GDP growth might be closer to half of the figures just above. Third, in the real world, the impact will not hit at one instance. Indeed, the Department of Education receipts figures examined above suggest that borrowers had already begun to adjust in July. Indeed, the August receipts number would suggest that the bulk of the drag had already transpired by last month. This makes the retail sales figures due out on September 14 especially interesting. If there was no clear pullback in retail sales last month, especially after spending was unsustainably robust in June and July, then it may be the case that the impact of the student loan payment resumption will be too small to notice.
The bottom line in my view is that the resumption of student loan payments is likely to have a minor impact on the aggregate economy, an impact that is probably already well underway.
Of course, the burden of student debt does not fall evenly across all households. Some families are going to be hit harder than others. The stereotypical story seen often in the popular press is of a relatively young adult who took out a massive amount of student debt and then either failed to complete a college degree or acquired one that offers modest earning power. For this archetype, the end of the moratorium could lead to significant financial stress that could have a wider impact on household finances, such as driving credit card and auto loan delinquencies higher.
However, I would note two points related to that. First, that archetype is the classic case that would benefit from the variety of income-based repayment plans, so many of these borrowers may have options for relief. At the extreme, I would add that people who fit this description likely represent a large proportion of the 13% of borrowers who were not making payments prior to the pandemic.
Second, as I noted in a piece on household finances last month, the actual incidence of the student loan burden differs substantially from the archetype described above. In fact, 71% of borrowers with a graduate degree owed more than $25,000, compared to 47% overall and only 28% for those with only a technical degree or who failed to gain a degree. In other words, a large chunk of the aggregate student debt burden is owed by those best able to pay it back: those with graduate degrees such as doctors, lawyers, MBAs and so on. The New York Fed/Equifax data found that at the end of 2021, over 60% of student loan debt was held by borrowers with a FICO score above 660.
Moreover, as I noted in that August piece, the Bank of America Institute found that as of May among the bank’s high-income customers (income over $100,000), those who stopped making student loan payments or only made irregular payments since 2020 had significantly higher average deposit balances than other households. Thus, many of the households with the largest student loan burdens have likely been preparing for the end of the moratorium for some time and are unlikely to need to sharply curtail their spending to make the renewed payments.