The Long-term Effect of Student Debt

A Comparison of Student Debt Payment Versus Investing Over a Working Lifetime.

Student debt is a growing rapidly in all Western countries, with a detrimental effect on millennial wealth. I will discuss some of the reasons for the rise in student debt, and then show what long-term effect this has on the wealth of those who take on these debts. But first, let’s quantify this issue:

The Numbers

Student debt has risen in the U.S. and other countries. To give an example, the average graduate debt in the U.K. was 16.000 pounds in 2011 and rose to 44.000 pounds in 2016. That is a near tripling of debt in just five years’ time. While student debt in the U.S. was less than half the size of credit card debt or auto loans in 2003, today, student debt is almost double credit card debt and auto loans combined. Total U.S. student debt has risen six-fold from 250 billion in 2003 to 1.5 trillion dollars in 2018, according to

Why Student Debt is Rising

One reason for the aggressive rise in student debt is that universities are charging more. Between 1980 and 2010 in the U.S., inflation-adjusted college tuition has risen threefold, which is far more than the median wage increase during the same period. Higher rents in university cities or on-campus living also have disproportionately affected students, for whom rent makes up a relatively high percent of their total expenses. So one reason for the rising student debt is simply that the cost of obtaining an education has risen.

Another reason is that governments are defunding education. The U.S. federal government is spending half as much on education as it did in the 1970s, with states picking up a large portion of the funding cuts. And for Europe as a whole, in 2002 governments spent 11.1% of their budget (5% of GDP) on education, and in 2016 they spent 10.2% (4.7% of GDP). So while the cost of education has risen, governments have provided less funding.

Then there is the increased importance of getting higher education. In the OECD (a club of mostly rich countries), the percentage of 25- to 35-year-olds with a tertiary education degree is at 43%, compared to their parents (those 55 to 65 years old) who have such degrees at a rate of 27%. This means that there is some ‘education inflation’ happening, in the sense that the base level of education is trending higher. With nearly half of the population highly educated, it seems more necessary to have an education in order to land a decent job. This education inflation pressures millennials to obtain higher education, even though this education is becoming less affordable. The increase in the number of students pursuing higher education coincides with shrinking government funding, which means that there is even less funding per student.

Long-Term Effects

When previous generations started to work (with or without education didn’t matter as much), they were ready to purchase real estate and other investments. But millennials have to pay off their student loans first. Assuming you start work at 25 and work for 40 years, what effect does a student loan have on your financial life when you are 65?

Modest Student Debt Payments Have a Big Effect Later

Student debt payments versus investments
Student debt payments versus investments

This first chart shows the effect of a modest, 20.000 student debt. I am not specifying a denomination for these simulations, but 20.000 is less than half the average debt in pounds for British students and also less than the average USD debt of US students. As mentioned before, previous generations could start immediately buying houses instead of renting, or buying other investments. So I will compare 20.000 in debt payments versus 20.000 in investments over the course of 40 years. I am assuming that per year, 10.000 in debt payments is made, and that the below-average student debt is paid off after two years.

For investments I am assuming an average 6% real return, which is less than the average since 1900 for the S&P500 – a major investment benchmark of 500 large, U.S. companies. It is also similar to the real return of buying a house with a mortgage, compared to renting. As you can see, the 20.000 invested in the first two years of ones career can be expected to grow to around a real 188.000 after 40 years. At that point, 6% real interest would mean that each year you receive more from the investment than the original 10.000 that you put in during the first two years.

Debt Payment and Investment

Student debt payments versus investing early in life
A head start on investing

Of course, you could decide to pay off the student debt in 2 years, and then start investing for an additional 2 years in order to also accumulate assets. After these combined 4 years you may deprioritize investments over having a larger home or children. To be fair, I will again compare it to a situation with no student loans and 4 years of investments that are equal to the debtors’ situation of 2 years debt payment and 2 years of investing.The effect on wealth after 40 years is still a difference of 188.000. The modest student debt has effectively slashed savings of the debtor in half over 40 years compared to the graduate without debt.

Large Student Debt

Large student debt payments versus investing
Large student debt

To see how crippling a large student debt is, I created another chart. In this chart, 100.000 in debt payments are made over the course of 10 years, each year paying off 10.000. The principle on this debt (the debt before interest) is closer to 85.000 at a 3% interest rate. But paying off 85.000 in principle at 3% interest rate over 10 years costs a total of 100.000. So in the following chart, I show the difference between investing (in real estate or stocks) 10.000 a year for 10 years, and making the same amount in debt payments.Once the debtor has paid 100.000 to pay off the 85.000 debt, the person who graduated debt free and also put away 100.000 already owns 130.000. This is because the 10 years of investing 10.000 a year already provided 30.000 in interest. At the end of the 40 years, paying off the 85.000 debt results in 3/4 of a million of wealth that is lost compared to someone who put away the same amount of money but had no debt to service.

Fiscal Caveats

These simulations don’t take into account the various tax implications of investments (taxed) and debts (often tax-deductible). But while investments can always be splurged away, in some countries (including the U.S.) it is not even possible to default on student debt – making it a lifelong ball-and-chain for some. I have also assumed a constant real 6% return on investment, but these numbers vary year to year, randomly affecting outcomes up or down. Finally, earlier generations did not necessarily graduate debt free either, although their real debt and debt-to-income levels were many times smaller, on average.

Solutions To Rising Student Debt

As shown above, the fast rise in student debt is set to have a major impact on millennial wealth down the road. If millennials had less debt they would have invested more or spent more. The causes of rising student debt are known and can be addressed. Governments should invest more in higher education, back to historic levels and beyond. Students should think twice about which university they choose, as some universities or cities are more expensive than others. Perhaps mass-online courses can reduce costs for staple university degrees, forcing colleges to spend less on chic buildings in order to compete with online courses. These changes in government funding, student choices, and college tuition cannot come soon enough. Already, we have a generation with much more debts and this debt increase will likely continue at least in the short term.

What do you think should be done to address the increase in student debt? Is studying still worth it? Leave a comment to let us know your thoughts!

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