Student loans have become an increasingly popular form of debt in recent decades as more students pursue higher education. However, many banks still view student loans as risky investments compared to other types of consumer debt. This hesitance largely stems from two key factors – the lack of collateral and high student loan default rates.
No collateral for student loans increases risk of losses
Unlike mortgages or auto loans, student loans are unsecured debt – there is no underlying asset like a house or car that can be seized in case of nonpayment. So if a borrower defaults on student loans, the lender has very limited recourse to recover losses. This lack of collateral is a major reason banks see student lending as riskier than other forms of consumer credit.
High and rising student loan default rates
Student loans have much higher default rates compared to other common debt products. Government data shows that over 11% of student loan balances are in default as of early 2022. And this rate has been rising steadily over the past decade, more than doubling from 5.2% in 2009. Such poor repayment performance means the profitability of student lending is much more uncertain for banks.
Post-graduation income unable to cover loan payments
A driving factor behind the high student loan default rates is that many borrowers struggle to find jobs that allow them to make their required monthly payments. Average starting salaries have not kept pace with the rapidly rising costs of college. So more graduates end up in financial distress, unable to afford their student debt on top of living expenses with their entry-level incomes.
Limited government guarantees insufficient to reduce risk
While the government guarantees a large portion of student loans, there are limits on these guarantees that still leave banks with significant risk exposure. For example, PLUS loans made to graduate students or parents have no government backing at all. And guarantees on federal undergraduate loans apply only when students default – if loans end up distressed but not technically defaulted, the banks face losses.
In summary, banks view student loans as riskier investments than other consumer debt due to the lack of collateral to secure the unsecured debt and much higher default rates, which lead to greater uncertainty around repayment and profitability.