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More bad news for student loan borrowers

April 22, 2013: 7:00 AM ET

Young, educated workers were once seen by banks as the most promising borrowers. That's no longer the case, thanks to student loan debt.

unemployment-college-graduatesFORTUNE – Graduation season is upon us. It used to be that in the years after hopeful twentysomethings bid farewell to campus life, they'd start borrowing to buy many things typically associated with adulthood -- namely, a car and a home. Many had college loans to repay, but that's partly what made brainy go-getters so attractive to banks and lenders. They typically earn more over a lifetime, so they seemed like a safe bet.

They may still be, but times have changed. College debt may have once been the good kind of debt, but the scale has grown so big that in many cases it has become more burdensome than helpful.

For the first time in at least a decade, 30-year-olds -- the median age of first-time home buyers -- with no history of student loans are more likely to have a mortgage than those with debts from school, according to a new report by the Federal Reserve Bank of New York. Studies have shown young people aren't borrowing as much as they used to, and the Fed says the burden of student debt may be the culprit.

The topic is especially important as the U.S. struggles to recover from the financial crisis and subsequent recession. Consumption makes up the bulk of the economy, and the spending power of young people has certainly helped drive that part of the growth equation.

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Between 2003 and 2009, home ownership rates were significantly higher for 30-year-olds with a history of school loans vs. those without such debts. The difference widened during the boom years, peaking to 4 percentage points by 2008. That all changed during the recession, however. Home ownership declined across the board but fell faster for those burdened by student loans. By 2012, one of the cheapest times to buy, the home ownership rate for student debtors was almost 2 percentage points lower than those without a history of student debt.

Indeed, the housing market still hasn't fully recovered from record foreclosures that caused prices to crash in 2007. But the burden of college loans has also hit the auto industry. Oddly enough, it comes at a time when auto companies from General Motors (GM) to Toyota (TM) report some of the strongest U.S. sales in years. As with home ownership, those with student debt are less likely to have a car loan than those non-borrowers.

All this reflects how college grads feel about their job prospects. During economic downturns, young workers usually feel the brunt of it, but the aftermath of the latest recession has been the longest period of economic weakness the U.S. has seen in more than seven decades. For young graduates under 25 years old today, the unemployment rate is 8.8%, compared with 5.7% when economic times were much better in 2007, according to a report released last week by the Economic Policy Institute. The underemployment rate, which includes those working part-time, is 18.3% compared with 9.9% in 2007.

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Graduating in a bad economy has long-lasting impacts. Over the next 10 to 15 years, graduates of the class of 2013 will likely earn less than if they had graduated when jobs were more plentiful, the EPI says.

If they haven't already, lenders are bound to view grads carrying student loans differently, the Fed suggests. Credit scores, which provide a snapshot of the risks of a borrower, have diverged between those with student loans vs. those without. In 2012, the average credit score for a 25-year-old without school debt was 15 points higher than that of student borrowers. The picture is bleaker for college indebted 30-year-olds normally ready to buy their first home. Their credit scores are 24 points below those without student loans.

The Obama administration has tried to ease the burden for young borrowers. Officials earlier this month cut commissions paid to private collection companies that chase overdue student loans. This may reduce the incentive to squeeze borrowers for all they have, but it does not help the job prospects of America's young people.

And until their career prospects improve, they'll continue to lag behind the economic recovery.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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