Underwater on Student Debt Understanding Consumer Credit and Student Loan Default

EDUCATION POLICY PRO GRAM

RESEARCH REPORT Underwater on Student Debt Understanding Consumer Credit and Student Loan Default

Kristin Blagg August 2018

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Contents iii

Acknowledgments iv

Executive Summary v

Underwater on Student Debt 1 Data and Methods 2 Patterns of Student Loan Default 6 Characteristics of Defaulters 9 Predicting the Likelihood of Default 15 Credit Effects of Default and Recovery 17 Policy Recommendations 23 Conclusion 26

Appendix A. Additional Figures 27

Notes 34

References 35

About the Authors 37

Statement of Independence 38

Acknowledgments

This report was funded by Smith Richardson Foundation. We are grateful to them and to all our funders, who make it possible for Urban to advance its mission.

The views expressed are those of the author and should not be attributed to the Urban Institute, its trustees, or its funders. Funders do not determine research findings or the insights and recommendations of Urban experts. Further information on the Urban Institute’s funding principles is available at urban.org/fundingprinciples.

I thank Matthew Chingos, Sandy Baum, Erica Blom, Jason Delisle, Preston Cooper, Cody Christensen, and Judith Scott-Clayton for helpful comments on earlier drafts of this report.

IV ACKNOWLEDGMENTS

Executive Summary

Even with a multitude of repayment and debt deferment options, about 250,000 federal direct loan borrowers see their loans go into default every quarter, and an additional 20,000 to 30,000 borrowers default on their rehabilitated federal student loans. In this report, I describe the relationship between a borrower’s credit profile and student loan default in a nationally representative sample of student loan borrowers, over the first four years of repayment.

My results indicate that the likelihood of student loan default is positively correlated with holding other collections debt (e.g., medical, utilities, 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). Those who will default on their student loans are more likely to reside in neighborhoods that have more residents of color and fewer adults with a bachelor’s degree or higher, but a borrower’s personal credit profile is a stronger predictor of default than the neighborhood where she resides.

Borrowers experiencing a student loan default see an average credit score drop of about 50 to 90 points in the year or two before the default. But those who default typically have poor to fair credit scores, even in the year before entering student loan repayment. Borrowers who default make less progress than nondefaulters in paying down their student loans (as a share of the initial balance), though those with smaller balances (less than $5,000) make more progress than those with