What’s Behind the Default Rate on Student Loans?

June 17, 2014

Households have engaged in significant deleveraging in the past few years, but student loan debt is still on the rise. In fact, student loan debt is now more prominent than any nonmortgage household debt. Unfortunately, the rise in student loan debt has been accompanied by a rise in default rates, which stand at 13.4 percent and 14.7 percent for students entering repayment in 2009 and 2010, respectively. A recent Economic Synopses essay examined what is behind the default rate on student loans.

In this essay, Alexander Monge-Naranjo, a research officer and economist with the Federal Reserve Bank of St. Louis, noted that high levels of student debt aren’t necessarily a problem if the returns from the investment in education are high enough. He reviewed two key components pertinent to obtaining a high return on investment in college:

  • Success in school (that is, earning a degree)
  • Success in the labor market (that is, finding jobs that pay well enough to justify the investment)

Earning a Degree

Monge-Naranjo examined the education attainment as of 2009 for students who finished high school in 2003-04. Degree attainment increases as the amount of borrowing increases: More borrowers with high debt ($30,001-$50,000) attained either an associate or bachelor’s degree than those with low debt. Also, more than half of those with greater than $50,000 in debt attained a bachelor’s degree, and more than 20 percent of them are still enrolled.

Paying Loans Back

In examining student debt repayment, Monge-Naranjo drew from a working paper he wrote with Lance Lochner, a professor at the University of Western Ontario. They used data on the cohort who earned bachelor’s degrees in 1993 to see where student loan repayment stood after five and 10 years in the labor market.

After five years, the number of people in default and deferment/forbearance was about 4 percent each. (The rest were either repaying their debt or had already fully repaid it.) After 10 years, the percentage of those in deferment/forbearance fell to 3 percent, while the percentage of people in default rose to 6 percent.

Monge-Naranjo and Lochner also examined the transition probabilities across different states of repayment for the same time period. The repayment status held in 1998 increased the probability of having the same status in 2003. For example, 17 percent of those in deferment/forbearance in 1998 also held that status in 2003. Only 2 percent of those with repaying/fully repaid status and 4 percent of those in default in 1998 were in deferment/forbearance in 2003.

Monge-Naranjo wrote, “If such a pattern holds for more recent cohorts, the true default rates for recent years are probably even higher than the measured ones because some default might be temporarily masked as deferment or forbearance. The default projections for recent cohorts might need to be downgraded even further, since the results of Lochner and Monge-Naranjo (2014) are for those with bachelor’s degrees entering a much better labor market.”

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