Student loan balances can have a significant impact on the economy because they prevent borrowers from moving forward with other financial plans such as buying a home or a car. Student loan debt hinders spending by limiting the amount of free cash in consumers' pockets. Learn about the different ways the U.S. economy could be affected with so many people burdened by student loan payments.
Key Takeaways
- Student loan debt can prevent you from making major purchases like a home or a car.
- An economy may see fewer new businesses when there is more student loan debt.
- Student loan debt also limits consumer spending.
- Economic recovery can be more difficult when there are many people carrying student loan debt.
The Economic Impact of Student Debt
As of September 2023, more than 43 million Americans held outstanding federal loan debt totaling more than $1.6 trillion. The amount of debt has led to concerns about potential economic impacts.
On a personal level, student loan debt can impact your finances when it limits other activities like buying a home, starting a business, or simply spending money on goods and services. When a significant number of people carry either federal or private student loans, the effect on the economy is generally negative because of reduced spending and other factors.
Here are several ways student loan debt can restrict your financial plans and impact the economy.
Fewer New Businesses
An increase in student debt has been found to correlate with fewer new small businesses, which are often cited as the backbone of the economy, per data from the Federal Reserve Bank of Philadelphia. In fact, the rise in student loan debt in recent years has indeed contributed to a decline in the number of new entrepreneurs aged 20 to 34, according to a study by the Ewing Marion Kauffman Foundation. New businesses add to economic growth in many ways, including by providing jobs.
Note
Student loan debt impacts your ability to get business loans to start a new venture, as it increases your debt-to-income (DTI) ratio. When you have to pay a student loan each month, you also have less cash to invest in your business.
Lower Rates of Homeownership
The drop-off in homeownership following the Great Recession was higher for those aged 24 to 32 than for the overall population. Student loan debt might have had an impact on that, with estimates indicating that every $1,000 in student loan debt reduces the homeownership rate by about 1.8% for those who attended public four-year institutions.
Rising home prices combined with both higher interest rates and student loan payments create a delay in the milestone of homeownership. Indeed, since student loan debt can impact your DTI ratio, that makes it more difficult to qualify for a mortgage with high student loan balances.
Struggles Amid Economic Distress
Carrying a lot of student debt can make it more difficult to keep up with payments during economic downturns. The need to repay your student loan can reduce your ability to build an emergency fund for necessary expenses should you lose your job or face unexpected bills. Many borrowers may turn to credit counseling services to help, but these businesses aren't always legitimate.
Reduction in Consumer Spending
Student loan debt can reduce people's ability to spend money, lowering consumer spending, which is a cornerstone of economic growth. Essentially, student loan debt lowers your disposable income, so you can't spend as much on discretionary items. In turn, businesses that sell these goods and services don't turn a profit. Student loan debt can also cause borrowers to delay important life milestones such as marriage, having children, and retirement, all of which require money.
The state of Pennsylvania analyzed the potential impact on the state economy when student loan payments resumed in the fall of 2023, and a decline in tax revenue was expected as a result, including a drop of $125 million in state income from sales and use taxes. Meanwhile, the New York Federal Reserve estimated that student loan repayments resuming in 2023 would lead to a $1.6 billion monthly drop in U.S. consumer spending.
Impact on Retirement Savings
When saving for retirement, those with student loan debt have a harder time than those without. Indeed, 84% of people with student loans said their debt limits their ability to save for retirement. When people have insufficient retirement savings and are more reliant on programs like Social Security, they have little choice but to live a more frugal lifestyle and spend less in retirement.
Disempowers Students
In some cases, student loan debt burdens disempower some students by limiting their financial or life choices. These students may be forced to make decisions they might not make otherwise to afford a higher education, such as sacrificing time that could be spent studying or resting to work a part-time job, in the hopes of a better income down the line.
Additionally, graduates who might otherwise seek work they'd find more fulfilling, such as lower-paid public service jobs, could turn away from this career path in favor of higher-paying jobs that will enable them to more easily make their loan payments.
Positive Impact of Student Loans
Even with some of the negative economic impacts of high levels of student loan debt, there are some positive aspects to consider as well. Research still indicates that those with bachelor's degrees earn more over their lifetimes than those with high school diplomas.
Graduate degrees, which would mean taking on more debt, can potentially further increase a student's earning potential. For example, men and women with graduate degrees earn, on average, $1.5 million and $1.1 million, respectively, more over their lifetimes than their counterparts with high school diplomas.
What Are the Long-Term Economic Consequences of Student Loan Debt?
Student loan debt can lead to the delaying of milestones, such as buying a home and starting a family, that generally require expenditures. The absence of these expenditures limits the economic growth of businesses that would have profited from them.
How Does Student Debt Influence Consumer Spending?
In general, if you have high amounts of student loan debt relative to your income, you are more likely to reduce your discretionary spending. With more money going to student loan payments, you have less to spend on other things. So, generally speaking, student loan debt reduces consumer spending.
How Does Student Debt Affect the Housing Market?
There are two factors that can be attributed to the negative correlation between student debt and homeownership. The first is that student loan payments strain a potential homeowner's budget, thus they may need more time to save up (and that's assuming they can even keep up with rising home prices). The second is that having outstanding debt increases your DTI ratio, which is a percentage that lenders often use to determine your borrowing risk. As such, a person with high student loan debt and a lower-paying job (which is likely to be the case for a recent graduate) may be unable to qualify for a mortgage.
The Bottom Line
Large amounts of student loan debt can reduce economic activity in a consumer economy in many ways. For individuals, it can strain your personal budget, which can result in you spending less. As part of a larger trend, this would lead to less spending, which is a major factor in economic growth.
