Will Debt-Ridden Grads Ever Escape Student Loans?

Debt is a dangerous tool. Used wisely, it can help you make investments that can propel you to heights you couldn't have achieved without it. But as millions of former students are finding out, used poorly -- or if you just run into some bad luck -- debt can put you into a deep hole financially, and it's harder than ever to get yourself out of that hole.

The state of the student loan industry
Yesterday, credit bureau TransUnion released a study that looked at the student loan industry over a five-year period from March 2007 to March 2012. The findings confirmed what many people already realized: Student loan debt has become a much more serious problem, as the impact of the recession and sluggish recovery from the financial crisis has hit job-seekers extremely hard and forced many graduates already saddled with debt to take measures to get relief.

In particular, some of the more troubling stats as of the end date of the study include the following:

  • More than half of all student loan accounts -- 65 million in all -- were in deferred status, with deferred loans making up well over 40% of the total outstanding balances on student loans.
  • Student loan balances in deferment soared by 75% over the five-year period to hit $388 billion, and average debt rose 30% to nearly $24,000 per borrower.
  • More than half of college graduates under age 25 are unemployed or underemployed.
  • Delinquency rates rose dramatically over the time period.

All of these data points show the unfortunate combination of (1) students believing that they need to go or return to school in order to boost their career prospects and (2) then finding that their college or graduate degrees don't come close to guaranteeing them any job at all, let alone one that justifies the substantial investment they've made in their education.

Why banks have opted out
One interesting piece of information revealed in the report points to differences between student loans that are backed by the federal government versus private student loans. Borrowers tend to prefer subsidized federal loans the best, because their terms are usually more attractive and provide for interest-free deferments. But when financial aid awards are insufficient to meet tuition, private lenders traditionally stepped in to bridge the gap -- often at high interest rates with less generous provisions for deferment or forbearance.

You might think that private loans would be more likely to be in default due to their more onerous terms. But surprisingly, private loan activity has become relatively unimportant in the industry. Federal loan balances nearly doubled from 2007 to 2012, but private loan balances barely budged. Moreover, delinquency rates for private loans were less than half the rates for federal loans, with private-loan delinquencies actually dropping over the time frame.

The trend away from private loans likely comes from bank decisions not to offer them. Bank of America stopped originating student loans more than three years ago, and as Fool contributor Amanda Alix wrote in mid-2012, other banks followed suit, with US Bancorp no longer taking applications for student loans as of last March and JPMorgan Chase planning to limit student loans to existing customers.

That doesn't mean you can't get private loans. Wells Fargo , Sallie Mae , and many other banks still offer them, and with Sallie Mae offering fixed rates as high as 11.85% and at least one Wells Fargo loan quoted at rates of more than 14%, these loans can be extremely lucrative for banks -- albeit while carrying substantial risk.

Be careful out there
If you're already in debt, the key takeaway here is to understand that getting into more debt isn't a good solution to your problem. Education is no guarantee of a well-paying job, so get a sense now of whether your chosen career path is likely to pan out. If prospects are dim, cutting your losses may help avoid bigger problems down the road.

Meanwhile, the easier lesson is for those in high school who haven't yet incurred college debt. Realize that college education is an investment, and you need to weigh the potential return on that investment before going into debt. If you're uncertain that a given school will give you the payoff you want, look for alternatives that will. Only once students and prospective students start thinking financially will the student-loan debt crisis come to an end.

Wells Fargo isn't afraid to make money from lending, and its shareholders have reaped the rewards since the financial crisis. For investors, does that make Wells Fargo a buy today? Find out by downloading our premium research report on the bank, written by one of The Motley Fool's top banking analysts. Click here now for instant access to this in-depth take on Wells Fargo.

The article Will Debt-Ridden Grads Ever Escape Student Loans? originally appeared on Fool.com.

Fool contributor Dan Caplinger owns warrants on JPMorgan Chase and Wells Fargo. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Learn about investing from the comfort of your own home.

Portfolio Basics

Take the first steps to building your portfolio.

View Course »

Investment Strategies

Learn the strategies you need to build a winning portfolio

View Course »

Add a Comment

*0 / 3000 Character Maximum