Underwater on Student Debt

Research Report

Underwater on Student Debt

August 13, 2018

Abstract

A quarter million federal direct student loan borrowers see their loans go into default for the first time every quarter, and an additional 20,000 to 30,000 borrowers default on their rehabilitated loans.

Previous research shows that the likelihood of default is higher for certain borrowers, particularly black borrowers, borrowers who go to for-profit schools, those who leave school without a degree, and those from low-income households. This report provides the first look at the relationship between a borrower’s credit history and her probability of default.

Using nationally representative data from one of the nation’s three credit bureaus and following student borrowers who entered repayment in 2012, this report sheds new light on who defaults. Of the cohort examined, more than 20 percent defaulted at least once within four years. Several patterns emerge among defaulters:

  • Borrowers who owe less than $5,000 were more likely than those with higher amounts of debt to default within four years. Higher student loan balances were associated with a decreased likelihood of default, even when controlling for the borrower’s location and pre-repayment credit profile.
  • The likelihood of student loan default was associated with holding other collections debt (e.g., medical, utility, retail, or bank debt). About 59 percent of borrowers who defaulted on their student loans within four years had collections debt in the year before entering student loan repayment, compared with 24 percent among nondefaulters. This share increased to about 75 percent in the year of the student loan default. Defaulters were more likely to have utility or medical collections debt, and nondefaulters were more likely to have credit card, auto, or mortgage debt.
  • Defaulters are more likely than nondefaulters to reside in neighborhoods that have more residents of color and fewer adults with a bachelor’s degree or higher.  A borrower’s personal credit profile is a stronger predictor of default than the characteristics of the neighborhood where the borrower resides, however.
  • Borrowers who defaulted saw an average credit score drop of 50 to 90 points in the year or two before default. Those who defaulted also typically had poor to fair credit scores before entering repayment.

Based on these findings, the report offers several policy recommendations:

  • Investigate the effect of debt and collections obligations on student loan repayment. Borrowers might be choosing to pay down other debt before addressing student loans. Policymakers interested in limiting defaults should further investigate the financial circumstances of defaulters.
  • Use credit scores to better target student loan repayment assistance. A low credit score should not keep an individual from getting a federal student loan, but it could be used to direct loan counseling or assistance to those who need it most.
  • Alter the way deferred, delinquent, and defaulted loans increase a borrower’s total student loan balance. Policymakers should look at the ways interest and fees accrue on student loan debt and consider adjustments that encourage, rather than discourage, repayment.
  • Focus on discharge remedies that reach the highest-need borrowers. Policymakers could consider a full or partial discharge of loans for borrowers who have spent several years in a social safety net program.
  • Develop better measures of student loan acquisition and repayment. The current system of tracking loan repayment by cohort does not capture the full picture of default and repayment.

Cross-Center Initiative

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