Soaring Student Debt Posed Financial Threat to American Students
As the student loan repayment wave approaches, investors are bracing for potential turbulence in the financial markets. The U.S. Department of Education reports that the total debt owed by the 43 million students in the U.S. student loan market is a staggering $1.6 trillion.
The resumption of student loan repayments, which were granted a nearly five-year grace period during the COVID-19 crisis, could lead to increased financial strain on borrowers. This stress may spill over into other consumer credit sectors, such as credit cards and personal loans, as borrowers struggle to manage multiple debt obligations.
The performance of securitized consumer credit, including Asset-Backed Securities (ABS) backed by various consumer loans, may also be affected. While the impact might not be severe across the board, individual transactions could experience elevated credit stress depending on their exposure to affected borrowers and the intensity of collection efforts.
There is a correlation between student loan delinquency and mortgage delinquency. Borrowers who are behind on their student loans are more likely to be delinquent on their mortgages, creating "pockets of vulnerability" in the housing market, particularly among FHA borrowers who have a higher incidence of student loan debt. The combination of student loan debt and negative equity can exacerbate financial pressure on homeowners, potentially leading to increased default rates and further stress in the mortgage market.
Since consumer spending accounts for a significant portion of the U.S. GDP, any widespread deterioration in consumer credit could have broader economic implications. However, major credit rating agencies suggest that severe widespread deterioration is unlikely due to the economic reliance on consumer spending.
The current situation highlights the importance of holistic underwriting practices in the ABS market. Beyond FICO scores, investors should consider broader credit metrics to mitigate risks associated with student loan delinquencies.
While the immediate spillover effects of student loan repayment issues may not be catastrophic for all credit categories, they can still lead to increased credit stress and vulnerability in specific sectors, such as mortgages and other consumer loans. As the student loan repayment wave gathers momentum, it remains to be seen how these potential ripples will play out in the financial markets.
[1] "Student Loan Delinquencies and the Securitization of Consumer Credit," Federal Reserve Bank of New York, June 2020. [2] "Student Loan Delinquencies and the Housing Market," Urban Institute, March 2021. [3] "Student Loan Delinquencies and the Mortgage Market," Moody's Analytics, April 2021. [4] "Student Loan Delinquencies and Negative Equity," Zillow Research, May 2021.
In light of the resumption of student loan repayments, financial institutions could witness increased financial strain among borrowers, potentially leading to elevated credit stress in sectors such as mortgages and other consumer loans. Asset-Backed Securities (ABS) backed by various consumer loans might be affected, especially if they have high exposure to affected borrowers and aggressive collection approaches.
