Are Student Loans Ruining The Economy?

A look at whether young adults can sustain steep increases in tuition.

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It’s no secret tuition increases are straining the finances of young adults. Student loan debt has nearly tripled over the last eight years. The total amount of money in student loans owed by Americans is more than $1 trillion and has exceeded credit card balances. Just how long can young adults sustain steep increases in tuition?

The national economic performance over the last five years has been disappointing. A recent article published by the Federal Reserve Bank of New York, “Student Loan Borrowers Retreat from the Housing and Auto Markets,” offers insight into the stagnation. Some of its findings include:

Home purchases. Student loans aren’t just the key to obtaining an academic degree; they’re also the key to buying your first home.

In the past, young adults with student loan debt were more likely to buy a house than those without student loan debt. In fact, in the years leading up to the recession, a gap emerged between homebuyers with student loans and those without. The gap grew as high as 14 percentage points in 2008, and then the paradigm shifted. Homeownership rapidly decreased among those with student loans until those without student loans were buying homes in greater proportion.

Home building and remodeling in the United States is a large engine for job growth. Yet homeownership might not be the only large purchase young adults are forbearing.

Auto purchases. Fed Reserve Bank researchers have found similar trends in vehicle and home purchases. Historically, those with student loans have purchased cars in greater proportions than those without student loans. However, consumer behaviors shifted starting in 2008, until 2012 – when those with no student loan debt were purchasing cars in greater proportion to those with outstanding student loans.

Cars purchases help fuel employment and growth in a number of industries across the country. But the sudden absence of many first-time homebuyers and car buyers is having a dramatic effect on the economy.

Credit scores may be to blame. Although student loan debt payments constrain household budgets, the high cost of college education may not be the only negative factor facing today's young adults. As debt levels rise, wage growth for college graduates has remained stagnant when adjusted for inflation. Consequently, student loans are having painful consequences on the credit scores of young adults.

Those with student loans saw substantial decreases in their credit at the same time banks implemented stricter credit requirements for loans. For example, in the wake of the recession, the Federal Housing Administration raised its minimum credit score requirement to 580. (Many banks require a score as high as 640 for an FHA mortgage.)

According to the study, the average credit score in 2012 for a 25-year-old college graduate with student loan debt was around 625, compared to 640 for a 25-year-old with no student debt. Student loans could be pushing graduates out of the lending market – making it harder to afford big purchases.

Consumer habits among young adults are shifting due to generational differences. A February 2013 survey by Zipcar showed young adults favor technology such as smartphones or computers over vehicles. As student debt rises, college graduates will continue feeling the strain on their credit, but what really matters is what strategies recent college graduates will employ to offset their student loan debt.

JP is a writer for the money blog 20's Finances. He is an MBA and the financial officer for a nonprofit organization.