Students in Distress

Student loan debt ballooned during the Great Recession, and student loan default rates have nearly doubled since 2007.  One leading explanation for the rising default rates has been the growth of “non-traditional” borrowers attending community colleges and for-profit institutions. The tendency of these borrowers to be older, from less-wealthy families, complete programs at lower rates, and have weaker labor market outcomes (employment and earnings) all contribute to higher default rates.

A recent working paper from the NBER suggests another potential avenue to explain part of the increase in student loan defaults. In Students in Destress: Labor Market Shocks, Student Loan Default, and Federal Insurance Programs (NBER Working Paper No. 23284), the study authors find the drop in home prices during the Great Recession accounts for approximately 24% to 32% of the increase in student loan defaults.

The mechanism for this effect follows a familiar narrative of the Great Recession: collapsing home prices triggered a sharp drop in household consumer spending, which in turn led to massive employment losses. Layoffs and earnings declines then weakened the ability of individuals with student loans to make loan repayments, especially if they had lower earnings to begin with. Previous studies have shown that student loan borrowers spend less time on their job search, needing to accept a job quicker to have income sooner. As a result, they earn less annually in the first ten years after graduation.

The study authors used individual-level student loan data linked to tax records and zip-code level data on home price changes to estimate these effects. They found a strong relationship between home prices, employment losses, and student loan defaults, especially among low income jobs, which accounts for about 24% - 34% of the increase in student loan defaults.

With regards to potential policy considerations, they find that the Income Based Repayment (IBR) program made it easier for borrowers to mitigate the effects of home price changes. Under the program, student loan repayments don’t exceed 15% of their discretionary income, and terms can be extended to up to 25 years. While the program provided valuable insurance for those who participated, student borrowers who were eligible for the IBR repayment option but did not actually take it up continued to default on student loans at high rates.