Is Student Loan Debt the Next Financial Crisis?

Although it's been more than a decade since the end of the Great Recession, the world still hasn't let down its guard. Now some believe the rising student loan burden could bring down the economy in much the same way as the 2008 and 2009 mortgage crises, but is that true?

Years after a payment pause of federal student loans due to the COVID-19 Emergency Relief and Federal Student Aid (CARES) Act, borrowers will need to begin repayments in 2023. While this may be a big burden on those households and could impact the economy, it's unlikely it will match the widespread devastation of the Great Recession.

Background

For generations, young people have heard that the only path to success is through a college education. College remains the accepted path for 61.8% of high school graduates, according to the Bureau of Labor Statistics.

For most students today, student loans are the way to pay the expenses of higher education. Federal student loan debt has reached historic proportions, topping $1.76 trillion in 2022.

Some believe that the problem will continue to get worse. Over the past 50 years, the rate of college tuition inflation has averaged about 8%, sometimes twice the normal rate of inflation. With college becoming a debt-creation endeavor and the economy often failing to compensate college graduates enough for their education investment, experts believe that more and more people will be unable to pay these loans.

Bankruptcy

Contrary to common belief, student loans can be discharged through bankruptcy proceedings, but it can be more difficult, according to the Consumer Financial Protection Bureau. Federally-issued student loans must prove to be an undue hardship for the borrower and, in some cases, may require an additional lawsuit known as an adversary proceeding to move forward. Some private loans may be discharged directly.

While the knowledge that bankruptcy is an option may provide some comfort, it should be the last resort. For many borrowers, student loans have inhibited them from moving forward in other areas of life—starting businesses, getting married, buying a home, and having children have all been listed as life events that are frequently delayed due to debt load.

2022 Student Debt Relief Measures

The burden of student loan debt hasn't gone unnoticed by the federal government. In 2022, the Biden-Harris administration announced its Student Loan Debt Relief plan, which is intended to forgive up to $10,000 per federal direct student loan borrower under a certain income level and up to $20,000 for those that had qualified for Pell grants.

However, the action has been met with legal challenges and remains in limbo. According to the Department of Education, it stopped taking new applications until further notice and is working to overturn the decision. Any applications that were already submitted were put on hold.

If the forgiveness program gets the OK from the court, the White House estimates more than 90% of the relief would go to households making less than $75,000. About 20 million borrowers would see their balances cleared, and lower loan balances for others would make it easier for them to resume repayments, especially those who struggle the most, according to the Consumer Finance Protection Bureau (CFPB).

But a defeat in the courts would mean borrowers will need to resume payments during a time when inflation and rising interest rates have increased their financial burden compared to before the pandemic. As of September, 2022, 7.1% of student loan borrowers were behind on their other debt compared to 6.2% before the pandemic hit, according to CFPB research.

Still, there are a few measures that could help avert disaster. The government removed all negative effects from loans currently in default, meaning those borrowers can resume payments without any past-due balance, just like other borrowers.

The Biden administration has also proposed a new income-driven repayment plan for federal student loan repayment that caps monthly payments at 5% of your monthly income. After 10 years, whatever remaining balance you have would be eliminated if the original loan balance was $12,000 or less. 

Earlier Debt Forgiveness Measures

Before the sweeping relief, targeted debt forgiveness had already taken effect for students who attended predatory or fraudulent schools. Students that attended several technical or vocational schools, such as ITT Technical Institute, may be eligible for federal loan forgiveness.

On a broader scale, the Public Service Loan Forgiveness (PSLF) program allows those that work in public service positions to receive debt forgiveness after 120 qualifying payments while working in a nonprofit or government job. Income-based repayment programs also aim to lessen the monthly financial burden for low-income borrowers.

The Bottom Line

There's no doubt that the student loan system is in desperate need of reform, but comparing it to the mortgage crisis may be inaccurate. Although the total amount of outstanding student loans now stands at about $1.76 trillion, that number is small compared to the roughly $11.92 trillion in outstanding mortgage debt. Programs aimed at lowering the debt burden may help alleviate the pressure on borrowers, but significant reform is needed to avert future debt rising even more.