What Skyrocketing Student Debt Means For the Economy

NEW YORK ( TheStreet) -- The Federal Reserve Bank of New York's quarterly survey on household debt revealed some eye-popping statistics on the growing problem of student debt.

Total student debt has essentially tripled in the last eight years to $966 billion in 2012 and is now the second largest category of household debt after mortgages.

Student debt was the only category to see an increase in the recession as enrollments increased and more students opted to stay in college in light of a miserable job market. The cost of education has also risen with college fee increases and more students pursuing graduate education.

But the rising cost of education was a problem long before the recession started. The number of borrowers and the average student debt balance have each risen by about 70% between 2004 and 2012.

The pursuit of higher education has the obvious promise of better job prospects and incomes, but a significant proportion of students appear to be trapped in debt.

As many as 6.7 million borrowers or 17% are more than 90 days behind on their payments- considered seriously delinquent. That is up from 10% in 2004.

The 17% delinquency rate actually understates the problem. This figure factors in borrowers who are not technically required to make payments because they have a period of forbearance before they have to begin paying down their loans.

Excluding those borrowers, the delinquency rate shoots up to 30%, with students below 30 being disproportionately affected.

Student debt, unlike other forms of debt, is not discharged through bankruptcy.

A recent Fortune Magazine article offers reasons why the student debt crisis hasn't quite received the attention it deserves from the market.

One obvious difference is that the student loan market is still a fraction of the mortgage market.

Student loans are also now being disbursed directly by the government and banks are not involved. So a student loan bust won't likely spark a financial crisis.

But as the article goes on to note, the government is using faulty accounting that encourages risky lending. That of course has serious implications for the taxpayer.

A Possible Dark Cloud for Mortgage Credit

The economists at the New York Fed highlighted other implications for the economy in their media conference Thursday.

According to their presentation, average non-student loan balances have declined for all borrowers aged 25 to 30, but the dip is particularly stark for borrowers with student debt balances of more than $100,000.

This likely reflects declining loan demand as well as difficulties in gaining access to credit. Borrowers delinquent on student loans are also likely to be delinquent on other forms of debt.

Student borrowers might also face difficulty accessing mortgage credit in the future. New mortgage rules framed by the Consumer Financial Protection Bureau require banks to ensure that borrowers have an ability to repay their mortgage. One requirement of the rule is that borrowers should spend no more than 43% of their income on loan payments.

Borrowers with huge student loan balances are unlikely to be able to take on a mortgage loan because many will fail to meet the debt-to-income limits. The lack of access to credit will likely limit demand not just housing, but also for consumer goods.

Of course, at least some part of the high delinquency rates can be explained by current economic conditions so if the job market picks up, the rates should decline.

Despite the dire trends in student loans, the economists do note that there is still a strong economic incentive to borrow for education. Americans with a bachelor's degree or higher earn nearly double that of high school graduates. Unemployment rates for those with a college degree are also lower.

-- Written by Shanthi Bharatwaj in New York.

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