The Fuse

Will Student Loan Debt Affect Vehicle Ownership?

by Hart Schwartz | February 12, 2018

Unprecedented levels of student debt could have long-term effects on vehicle ownership.

Student loan debt has grown rapidly since the early 2000s, and unprecedented levels could have long-term effects on vehicle ownership, via drags on household spending decisions. The following chart shows student debt growth from 2003 through 2017. Later charts will break out loans owed by age cohorts, illustrating the long-term nature of the problem.

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The trend is straight upward. In 2003, student loan debt totaled $253 billion, and by 2017 it reached $1.357 trillion, more than a fivefold increase. In 2017, student loans represented 10.5% of all household debt, up from 3.1% of household debt in 2003.

The staggering growth in student-loan debt may pull down economic growth, because repayment stretches out for decades. Monthly debt payments of several hundred dollars, or more, mean that personal vehicle ownership may become impacted. At the margin, households may choose to own fewer vehicles to account for the need to make student loan payments. Moreover, families may avoid purchasing homes in low-density suburbs where driving is the norm, instead opting for rental of urban apartments in high-density urban places where they can utilize a variety of options such as ride-sharing, car-sharing, transit, bike-shares, and walking. Families that avoid purchasing a house may also wish to avoid a fixed long-term mortgage commitment when they already have a fixed long-term commitment of student loan payments.

Families may avoid purchasing homes in low-density suburbs where driving is the norm, instead opting for  urban places where they can utilize a variety of options such as ride-sharing, car-sharing, transit, bike-shares, and walking.

Of course, many caveats and qualifiers (income, family size, location of employment, and other factors) could require income to be devoted to owning a vehicle even in the presence of large student loan debts. Nevertheless, such large amounts of student debt are owed by such a large number of people that it seems that loans are likely to become a significant background factor when making decisions about vehicle ownership over the next several decades. The relevance of student debt becomes even more acute when one considers that vehicle ownership includes not only the purchase or leasing prices of the vehicle, but also the costs of gasoline, insurance, repairs, and more. These ancillary and ongoing costs also come into play and might be crowded out by student loan payments.

As if the foregoing were not enough, student loans contain hidden “time bomb” costs that many people are unaware of, causing an even greater material impact on household balance sheets. Firstly, loans accrue interest over time. If a loan is large enough, the annual accrued interest may be larger than payments made during that year under a reduced-payment plan. Secondly, loan forgiveness is taxed as unearned income in the year that it is granted, thus leading to a substantial tax liability in that year of supposed “forgiveness.” For example, the most common repayment plan (“Pay As You Earn,” aka PAYE) offers forgiveness after 240 months of reduced payments. But the outstanding balance, when “forgiven,” can be taxed at rates as high as 25 percent or 30 percent. In that year, $100,000 of forgiven loans (not an uncommon sum) would translate into a tax bill of $25,000 or $30,000.

This debt trap highlights the importance of taking a long-term perspective on the impact of student loan debt. In the short-term, it is true that nothing much appears to have changed. In 2015, per-capita vehicle ownership in the United States remained at a world-high level of 820.1 vehicles per 1,000 people, according to Transportation Energy Data Book, produced by Oak Ridge National Laboratory. Moreover, a previous article in The Fuse showed that vehicle ownership trends have been remarkably flat, and stable, over the past decade.

Nevertheless, what about the long-term? Will there be a lagged effect on future vehicle ownership? Age-based demographics in the following charts provide insight, because looking at loan obligations by age cohort reveals that, unless something unexpected happens, student debts of individual households will last for decades, and will likely increase over time.

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Average debt per person has grown too (see below chart), indicating that increases in total debt were not due simply to more holders of debt. Rather, the average household that holds student debt faces a trend of growing financial obligations, as interest accumulates every year. In every age cohort, average per-person student loan debt has increased since 2004. Older cohorts (30-and-over) have seen the most dramatic increase in average debt obligations per person.In the popular imagination, the holders of student loan debt are university students and graduate students. However, in reality, more debt is collectively owed by those over the age of 30 than those under the age of 30. Repayment occurs over decades, in a long-term process. Thus, interest accumulates. Each over-30 age cohort has seen a major increase in outstanding debt and number of debtors.

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These charts suggest many outstanding loans will not be fully paid for decades. Current debtors will proceed through a generational cycle—they will have children, the children will grow up and go to college, and all the while, the parents’ original loans may still be in payment, accumulating interest.

Common sense suggests that student loans should affect household spending. To assess this conjecture, there are several qualifiers to consider: Income-based repayment, congressional action, and taxation of loan forgiveness.

1) Income-Based Repayment

Many borrowers repay according to “income-based repayment,” in which the U.S. federal government permits a reduced monthly payment based on percentage of disposable income. There have been various income-based repayment plans, each with different percentages of income. The most recent version is known as “Pay As You Earn” (PAYE). Loan payments are capped at 10 percent of monthly disposable income, the lowest rate of any available plan.

However, even at this low rate, student loans could still take a substantial cut of the household budget. Under PAYE, somebody earning $60,000 to $80,000 per year could still pay several hundred dollars per month, or several thousand dollars per year. Could this cash obligation crowd out funds that could be used for leasing or buying a vehicle?

2) Congressional Action

Many times over the years, Congress has tinkered with student loan schemes, for instance creating new types of instruments such as the Graduate PLUS loans, or designing new income-based repayment formulas such as PAYE. The media has even rumored that recent tax reform may change some student-loan provisions. It will take time to evaluate the bill’s full impact. Any movement toward stricter payback terms could create an additional cash-flow drain for households.

3) Taxation of Loan Forgiveness

Under the PAYE plan, loans are completely forgiven after 240 months (20 years) of payments. Surprisingly, “forgiveness” may not be so forgiving. A little-known fact of the federal tax code stipulates that in the year of supposed student-loan forgiveness—when all 240 months of payments are completed—the “forgiven” debt gets taxed as unearned income. Tax rates may range as high as 25 to 30 percent, meaning $120,000 forgiven would be taxed $30,000, and $40,000 forgiven would be taxed $10,000.

The taxability of loan forgiveness may come as a great surprise to many people. It does not seem to fit the common-sense meaning of “debt forgiveness.” If this situation becomes more widely known, it could impact long-term financial planning of potential vehicle purchasers. Households may seek to shift assets in preparation for eventual taxation, thus crowding out funds for vehicle purchase.

The long-term effect on vehicle ownership?

Other countervailing factors, as yet unknown, may change the student-loan picture, especially when the overhang of repayment schedules extends decades into the future. A future president or Congress may assume unexpected policy preferences. Other unforeseen changes may occur too.

How much will student loan debt affect vehicle ownership, and consequently, driving, and fuel consumption?

Nevertheless, the current, known situation shows an increasingly educated U.S. population confronting sharply increasing college costs and mountains of debt. Since the 1950s, the dawn of a “knowledge economy” has spurred college education rates to increase from under 30 percent to over 60 percent of adults with at least “some college,” according to the U.S. Census Bureau. Since the 1980s, annual tuition has risen, on average, more than eight times while general consumer inflation has only increased by 2.4 times. In other words, higher education costs have risen four times faster than general consumer prices, according to the Consumer Price Index, Bureau of Labor Statistics. How long can this continue? How much will student loan debt affect vehicle ownership, and consequently, driving, and fuel consumption? Awareness of the data presented in this article, on long-term student loan payment obligations, can serve as a valuable starting point for debate.

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