Student loans have become an increasingly important way for students to finance higher education. However, many banks are hesitant to invest heavily in student loans due to the high risks involved. There are several key factors that contribute to the risky nature of student loans from a bank’s perspective. These include the lack of collateral, high default rates, and difficulties predicting future income of student borrowers. Understanding why banks see student loans as risky can help students make wise borrowing decisions and help policymakers improve the student loan system.
No collateral and bankruptcy protections make student loans highly risky
One major reason banks see student loans as risky is that they are unsecured debts. Most other common types of loans like mortgages and auto loans are secured by physical assets that can be repossessed. But there is no collateral behind student loans, so if a borrower defaults, the bank has no recourse. On top of this, student loans are very difficult to discharge in bankruptcy except in cases of proven undue hardship. So defaulting student loan borrowers remain indebted indefinitely. These protections for lenders seem appealing, but also leave banks exposed if borrowers cannot or will not repay.
Many student borrowers struggle to find jobs and repay loans
Banks also see risk in the difficulty predicting student borrowers’ future income potential. Students often take on loans betting their degrees will lead to high-paying jobs. But unemployment and underemployment among recent graduates is high, making it harder for borrowers to repay. The Covid-19 pandemic has exacerbated these issues. With late payments and delinquencies on student loans at historically high levels, banks are wary to invest further in this market.
Rising tuition and debt loads signal an unstable market
Moreover, the soaring costs of higher education means students must take on more debt. Average per-student tuition has doubled over the past 30 years even after accounting for inflation. As a result, nearly half of borrowers owe over $20,000 and the total U.S. student debt balance recently topped $1.7 trillion. From a bank’s perspective, this growing debt burden coupled with uncertain job prospects among graduates makes student lending appear highly unstable.
Programs exist to share risk but questions remain
Some federal programs like Income Driven Repayment plans help reduce risks for student lenders by capping payments at a percentage of income. But banks remain exposed when graduated payments cannot cover accruing interest, leading to negative amortization. While these programs show promise, banks perceive the student loan market as flooded with indebted graduates facing uncertain futures. So despite federal safeguards, banks still view student lending as a risky investment compared to mortgages and other common assets.
In summary, student loans lack collateral, are difficult to discharge, and require predicting volatile graduate incomes, all factors that make this asset class highly risky from a bank’s perspective. Understanding these risks provides needed context on banks’ conservative approach to student lending.