Student Loan Debt Is Creating Generation Of High-Risk Borrowers With Low Credit Scores

Lots of people graduate college with minimal credit histories. Repaying student loans was always a dependable way to build that history. But recent, rampant growth in student loan debt in the U.S. could slow that process for an entire age group.

The folks at FICO, the very people you need to impress in order to get that gleaming credit score when it comes time to get a mortgage, have just released the results of a study showing the negative impact student loan debt (now totaling more than $1 trillion in the U.S.) is having on credit scores and credit risk.

“Consumers opening student loans more recently are generally higher risk than those in older vintages,” writes FICO. “This coincides with the fact that student loan default rates are much greater today… Additionally, analysis of millions of credit profiles reveals a marked increase in student loan debt. This greater debt and the challenging labor market for recent graduates will continue to cast a dark cloud over the industry.”

DOUBLE THE DEBTORS
Between 2005 and 2012, the number of U.S. consumers with at least two open student loans more than doubled, from 12 million to 26 million. During that same amount of time, the average amount owed on student loans went from $17,233 to $27,253.

So you suddenly have twice the number of people, each carrying 58% more debt than only seven years earlier.

The FICO study also found that there are now around 1.2 million consumers with student loan debt of at least $100,000. That’s four times the number of people carrying that heavy amount of debt in 2005.

ADULT DELINQUENTS
As more people have racked up higher levels of student loan debt, a higher percentage of borrowers are failing to pay.

Comparing loan delinquency rates between two periods (2005-2007 vs. 2010-2012), FICO found that there was a 47% increase in borrowers who were at least 90 days behind on their payments, with more than 1-in-4 loans opened prior to 2010 now in delinquency.

EFFECT ON CREDIT SCORE
FICO looked at how these factors have impacted the credit scores of consumers with student loan debt. Comparing scores for borrowers with existing student loans, FICO saw that between 2005 and 2010, there were increases at the lowest and highest points on the spectrum, with a distinct drop in the middle range of scores.

The number of active borrowers with scores below 600 or above 780 was higher in 2010, while noticeably lower in the middle ranges where one would expect to find younger adults with college experience.

FICO says it doesn’t have enough data to provide a definitive answer for this result, but it believes that the lower end is a result of the younger borrowers who left school to face a tough job market, while the increase in the high credit scores is likely due to older borrowers with jobs who responded to the recession by being more responsible about their credit and finances.

This theory is supported by data showing that borrowers with new loans in 2010 have lower credit scores than their counterparts did five years earlier.

A RISKY GENERATION
In the 2005-2007 period, student loan borrowers with more than $100,000 in debt were actually considered the least risky. But in 2010-2012, that evaluation flipped, with those borrowers now considered 1.1 times riskier than the total population.

In fact, for all tiers of student loan debt above $40,000, newer borrowers represent a higher level of risk than they did only years earlier. And even for those borrowers owing less than $40,000, the risk level remains virtually unchanged.

So there’s more borrowers, taking out more money that they don’t or can’t repay, and who will then have lower credit scores and won’t be able to take advantage of historically low interest rates on mortgages and other lines of credit.

WE BELIEVE THE CHILDREN ARE THE FUTURE
Back in August, we spoke to Rohit Chopra, the Consumer Financial Protection Bureau’s Student Loan Ombudsman, about this very phenomenon.

Chopra used the analogy of slapping a huge debt-filled backpack on the shoulders of college graduates, weighing them down for the rest of their life and preventing them from keeping up with their counterparts who aren’t laden with debt.

Studies already show that homeownership and 401(k) participation is dropping among U.S. consumers in the 25 to 29 age group, and there are indications that this same age group won’t be prepared to pay for the college education of its offspring, let alone save for retirement.

Both FICO and Chopra agree that the key to preventing this going forward is education and making consumers more aware of what they are getting into when they take out these loans that will never go away, no matter how hard one tries to ignore them.

“Because of the growing risk in the student loan segment, financial education is even more critical,” writes FICO. “It is important to [borrowers’] future financial health that they understand the long-term ramifications of their financial decisions.”