In the 1970s, most people could expect to graduate college debt-free, provided they worked full-time in the summer and applied for a scholarship or two. In 2018, graduating debt-free is like paying off a mortgage in four years.
That’s not an exaggeration. In fact, data from the Federal Reserve Bank shows that student loans have risen from $481 billion to more than $1.45 trillion in 12 years—making student-loans the second-largest form of household debt next to mortgages.
On top of that, student loan delinquency rates are up to 11.5 percent nationally, and as high as 16 percent in West Virginia, Arkansas and New Mexico. With mortgage rates at a much more modest 1.5 percent, it’s not so much a question of whether student loans will overtake mortgages as the largest source of household debt, but when. Beyond that, why is it happening?
Why student loans are overtaking mortgages
Despite growing student loan balances, colleges have not found ways to make tuition more affordable for students.
A 2017 report from Experian found that student loan balances are increasing each year. In the past decade, they’ve risen a whopping 62 percent. The Consumer Financial Protection Bureau also released data saying that the number of borrowers owing $50,000 or more has tripled within the last 10 years.
Student loans are increasing partly because of the rise in tuition, which continues to outpace inflation. Some universities raise tuition at double the rate of inflation, which makes a huge difference year after year.
Why default rates are rising
As troubling as the rise in student loan balances is, the rise in default rates is even more worrisome. The Federal Reserve found that the delinquency rate for student loans—meaning that a payment is more than 90 days overdue—was 9.3 percent. The next-highest delinquency rate was 4.6 percent for credit card debt, followed by 2.3 percent for auto loans.
Student loan default rates are higher than other kind of loan, including mortgages, partly because lenders don’t do an extensive credit check before giving you a loan. If you want to buy a $200,000 house, the loan officer will make sure you can afford to pay the mortgage every month, combing through your bank account, verifying your savings and checking your employment history—not so for student loans.
When you sign up for student loans, the lender has no idea how much you’ll be earning after you graduate. They’ll happily lend you the money, whether you’re aiming to be a software engineer for Google or a preschool teacher for a low-income school system.
High school kids are still taught that the only way to land a good job is to get a university education. They feel pressure to attend college and often receive little guidance on how much they should borrow.
Unfortunately, many students and parents are also unaware of the available scholarships that could drastically cut down the need for student loans. In 2014, students left $2.9 billion of free federal grant money on the table.
How to prevent defaulting
Defaults are increasing, but that doesn’t mean you have to be a part of the trend. Here are some ways to avoid missed bills and late payments.
Refinance your loans
Sick of high monthly payments? Look into refinancing your student loans to a lower interest rate or smaller monthly payment. Refinancing student loans is a good option for those with high monthly bills and high interest rates. We recommend Even Financial, SoFi or Earnest.
When you refinance, a new lender will take over your existing loan and offer you a revised loan contract. That new offer will likely include a better interest rate, which can lead to thousands in savings.
You can also choose to structure your new loan to have the lowest monthly payment available. That will give you the flexibility to pay less when times are lean, as well as the freedom to pay extra when you can.
If you refinance your federal loans, you’ll lose access to income-based repayment options and Public Service Loan Forgiveness, so do your research before choosing that route.
Choose an income-based plan
Increasing student loan balances and stagnating salaries are the main causes for rising default rates. If you’re earning $30,000 a year and owe $80,000 at 4.45 percent interest, your monthly payment will be $888 with a gross monthly income of $2,500 before taxes. After rent, groceries, health insurance, gas and utilities, it’s no wonder someone in this situation would struggle to afford that student loan payment.
Borrowers with federal student loans can switch to an income-based repayment plan if the standard plan’s monthly payments are too high for them. The same borrower with $80,000 in student loans could pay as little as $99 a month under the Pay-As-You-Earn or Income-Based Repayment plan. Your monthly payments will be recalculated every year to account for a higher income or change in family size.
Income-based plans have longer repayment terms, usually between 20 and 25 years, so if you stick with the plan for the full period you’ll end up paying more in interest. Still, it’s a good stopgap if you’re about to default on your loans and want to preserve your credit.
Ask for deferment or forbearance
Deferment and forbearance are two options for borrowers failing to make their payments on time. These strategies allow graduates to take a 12-month break from making payments, during which time they can focus on creating a solid financial foundation to build from.
The difference between deferment and forbearance lies in whether or not the applicant has to pay interest during the 12-month period—with forbearance you do, with deferment you do not. Borrowers with Direct Subsidized or Perkins Loans don’t have to pay interest during either.
Those curious about forbearance or deferment need to apply for the program and provide a reason they’re experiencing financial hardship. Losing your job, starting grad school and entering a rehab program are some of the most common allowable reasons for entering deferment or forbearance.
Student loans now surpass mortgages in the debt world. But who’s really surprised by that? With the cost of education rising dramatically in the last decade, it’s no wonder that millennials have a hard time even imagining themselves as homeowners.
However, these few tips above can help you climb out from under your student loans.