While the new quarter has started with a bang for the capital markets and those 1% who actually benefit from one after another record high courtesy of the Fed's "fairy dust [4]", July 1 is an important date for another group of Americans: students. However, instead of more wealth, America's aspiring intelligentsia has something far less pleasant to look forward to, namely more debt, because today is when higher interest rates for education loans kick in. Starting July 1 all new loans for the 2013/2014 student year will increase from 3.86% to 4.66% [5], a 20% increase.
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As a reminder, while the rate on student loans was lowered to 3.4% during the financial crisis, last summer this reduction expired which would have caused the rates to double to 6.8% had it not been for a last minute deal linking loan rates to US Treasurys, which luckily for students, are at historic lows for now.
Yet while the 80 bps increase per annum may seem like a lot when starting from a sub-4% base, according to Bloomberg calculations [7]"the average monthly payment would go up about $10 a month—an amount that won’t make or break many borrowers. Over 10 years, the increase could add about $1,350 in interest expenses."
This math is based on the assumption that the average graduate with debt, which would be 7 out of every 10, had on average some $29,400 in loans. Of course, since the rate hike affects future debt incurrence, that calculation is wrong. As for the trend, it is not a US student's friend [8]:
The national share of seniors graduating with loans rose in recent years, from 68 percent in 2008 to 71 percent in 2012, while their debt at graduation increased by an average of six percent per year. Even though the financial crisis caused a substantial decline in private education lending while these borrowers were in school, about one-fifth (20%) of their debt is comprised of private loans, which are typically more costly and provide fewer consumer protections and repayment options than safer federal loans.
In other words, a far greater issue for students is not the interest on the debt, but the debt itself, which in a time of ZIRP has become equivalent to money (it isn't) and students have had little reluctance to borrow every possible loan they could find resulting in a student loan bubble of epic, $1.1+ trillion proportions. Will today's rate hike - modest as it may be - be the pin that pops it?
As for the rate hike, Bloomberg has some soothing words:
In recent years, the increased income graduates earn has generally kept up with rising student loan payments. Borrowers whose monthly loan expenses are out of whack with what they earn also have additional back-up repayment options. Whether the overall affordability will hold up depends on a number things, including how much and how quickly rates rise. Congress’s cap on undergrad student loans stands at 8.25 percent. Given the average debt in the example above, rates at that level would add about $65 a month in payments—almost $14,000 over a loan’s duration.
Of course, this too is based on a flawed assumption: that college graduates can find work. Unfortunately, as the following chart showing the labor participation rate of Americans aged 20-24, or those graduating from college, the labor force is increasingly more devoid of recent college grads. The result: an overabundance of those who "earn" zero income. It is here that even the smallest increase in rates will be felt most as there is no income to offset any interest payments with, let alone increasing interest.
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Finally, and as we have shown repeatedly before, those students who are angry that they are saddled with tens of thousands in debt and nobody is willing to hire them, perhaps they can take it up with their parents: that particular age pool (55 and over) has practically never had it better when it comes to work opportunities also known as "retirement as a Wal-Mart greeter."
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Finally, those curious what the average student debt breakdown is by state as well as the proportion of students with loans in the most recently reported Class of 2012, here is the full data:
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