Student Loan Borrowers with Lower Outstanding Balances More Likely to Default
April 2, 2015

Data released by the Federal Reserve Bank of New York last month showed that student loan delinquency rates were rising. In its Household Debt and Credit Report for the fourth quarter of 2014, the Federal Reserve Bank of New York declared that:

  • Outstanding student loan balances amounted to $1.16 trillion
  • The corresponding figure for the first quarter of 2005 was merely $363 billion – a third of its current value
  • Delinquency rates for student loans dipped from 11.1 percent in the third quarter of 2014 to 11.3 percent in the fourth quarter – a figure which denotes that approximately one in nine student loans is past due

Which Group of Borrowers is More Likely to Default on their Student Loans?

When people think about student loan defaults, they usually conjure up images of struggling college graduates encumbered with massive amounts of debt. But the reality is quite different. The Federal Reserve Bank of New York compiled a report highlighting that it was student loan borrowers with the lowest levels of debt who were most delinquent.

The report found that borrowers with the least amount of student debt ended up having the hardest time when it came to repaying their loans. The underlying cause behind this behavior was that many of these borrowers didn’t actually end up finishing college.

The Federal Reserve Bank of New York compiled data on the default rates of the 2009 cohort based on their school-leaving balances. It found that the highest default rates comprised borrowers who owed less than $5,000 on their student loans. These borrowers made up 21 percent of the 2009 cohort and had a default rate of nearly 34 percent.

At the other end of the scale were borrowers who owed over $100,000 on their student loans. Comprising three percent of the 2009 cohort, this group of borrowers had a default rate of approximately 18 percent. The default rate of these borrowers was nearly 50 percent lesser than the defaulting borrowers with outstanding student loan balances of less than $5,000.

A quick glance at the other categories of student loan defaulters with outstanding balances ranging from $5,000 to $100,000 reveals that this is not an aberration. As the outstanding balances of these borrowers increases, the default rates become progressively lower.

When are Student Loan Borrowers More Likely to Default?

The analysis by the Federal Reserve Bank of New York examined the phase when borrowers were more likely to default. In its study, the Federal Reserve Bank of New York analyzed cohort default rates:

  • Three years after the borrowers left school
  • Five years after the borrowers left school and,
  • Nine years after the borrowers left school

The analysis concluded that default rates witnessed a growth after three years and that the Great Recession aggravated the performance of cohorts further. For this analysis, the Federal Reserve Bank of New York used Consumer Credit Panel data for arriving at the conclusion that the default rates for the cohort of 2009 increased by seven percent in the three-to-five-year phase after leaving school.

However, the analysis also revealed a worrying trend. It showed that the cohort default rate schedules have progressively worsened with time. For example, the default rate for the 2005 cohort touched 25 percent nine years after the cohort left school. Similarly, the default rate for the 2007 cohort touched 24 percent seven years after leaving school – two years faster than the cohort of 2005.

Yet, the numbers for the 2009 cohort easily surpassed those of the 2005 and 2007 cohorts. The default rate for the 2009 cohort touched 26 percent merely five years after the cohort left school. In short, the default rates of recent cohorts will worsen with time and at a faster rate than the preceding cohorts exhibited.

The Federal Reserve Bank of New York cautions that the data does not reflect the entire picture for the 2009 borrowers who will default in the coming years. The estimates of the Federal Reserve Bank of New York indicated a 19 percent three-year default rate for the 2009 cohort. Yet the data shows that just two years later, an additional seven percent of student loan borrowers have defaulted on their loans.

The default rate patterns for earlier cohorts demonstrates this pattern aptly. For example, the cohort of 2005 had a three-year default rate of only 13 percent. However, nine years later, the default rates for this cohort have nearly doubled to 25 percent.

What It All means

The analysis nullifies the prevailing notion that borrowers with high outstanding student loan balances tend to default more frequently than those with lower balances. Borrowers with lower outstanding balances on their student loans default more frequently than borrowers with higher outstanding balances by as much as 50 percent.

Policymakers often focus on students with large amounts of student loan debt, but they might be better off looking at the other end of the spectrum.