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The Next Financial Crisis Has Begun

Many families see a college education as a necessity for their children to succeed in life. Paying for college, however, has become increasingly difficult, and more families than ever have had to resort to student loan debt in order to get the education they want.

According to figures from the Pew Research Center, the number of households having student loan debt hit a record level in 2010. With nearly one in five households having to deal with paying off loans in a tough economy, the resulting strain on finances is reaching crisis proportions.

The uneven impact of student debt
As you'd expect, student debt hits the young particularly hard. More than two-thirds of all debt is held by those under age 45, and those younger than 35 hold almost half of all outstanding student loans.

But the place where the impact of debt really shows itself is in the Pew report's breakdown of loans by income level. For those in the lowest fifth of the income scale, student loans account for almost a quarter of total household income. That compares to just 2% for those in the richest 10% by income.

Overall, though, student loan debt is becoming a bigger part of everyone's lives. With student debt making up 5% of all debt in 2010 and recently surpassing the $1 trillion mark, young generations are starting to take it for granted that they'll end up having to be in debt for the first part of their lives.

Second-order effects
Clearly, student loans lead young graduates to make trade-offs. Rather than basing a career choice purely on issues like what one wants to do most and quality of life, those with significant student loan debt have to consider taking higher-paying jobs, even if they involve conditions they'd just as soon avoid.

But the second-order effects of student loans ripple out across the entire economy. Young people with significant student loan debt are less able or willing to buy homes, hurting homebuilder Standard Pacific (NYSE: SPF  ) and its industry peers. You're less likely to be able to afford a car, hurting Ford (NYSE: F  ) and other automakers. Even smaller discretionary purchases add up, leading to cutbacks like eating out less, which hurts local restaurants and other businesses.

How to fight back
The best way to address the student loan crisis is to avoid loans in the first place. That means making some smarter choices with your education and remembering to consider the cost-benefit analysis of taking on debt in order to invest in your future.

First and foremost, the old wisdom that paying up for a college education would automatically pay off in the long run isn't necessarily true anymore. With dramatic increases in tuition and other costs, schools have captured a lot more of the value of higher education. Moreover, the costs of particular colleges don't correlate well with their relative perception among employers, making certain high-priced college choices inferior to lower-cost schools as far as post-college prospects are concerned.

Second, don't let economic downturns tempt you into taking on more debt. Enrollment rises during tough times, and for students who are returning to school to gain valuable skills, that may be a smart move. But staying in school just because job prospects aren't good just delays the inevitable.

Finally, be sure to shop around for the best loan deals, especially if you're considering private loans. Bank of America (NYSE: BAC  ) suspended its student loan originations almost three years ago, and other banks have also cut back on student loans, but Wells Fargo (NYSE: WFC  ) and Sallie Mae (Nasdaq: SLM  ) are just a couple of the many lenders that will make various types of student loans. With private loans, lenders have a lot more flexibility, so comparing terms can save you a bundle over the life of your loan.

Get the best prospects
Planning for college is tough, but dealing with debt after college is even tougher. Those who are already mired in debt face the huge challenge of digging their way out of it, but if you still have time to take steps to avoid the full brunt of college debt, it will greatly help prevent you from being an unwilling participant in the next financial crisis.

Instead of getting stuck in debt, you can turn around and profit from it. Bank of America may have scaled back its student loans, but it's still making plenty of money from lending. Find out about its prospects in the Fool's premium report on Bank of America, which you can get easily just by clicking here.

Fool contributor Dan Caplinger hates debt of all kinds. You can follow him on Twitter @DanCaplinger. He owns warrants on Wells Fargo. The Motley Fool owns shares of Ford, Wells Fargo, and Bank of America. Motley Fool newsletter services have recommended buying shares of Ford and Wells Fargo, writing naked calls on Standard Pacific, and creating a synthetic long position on Ford. 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 Fool's disclosure policy owes you everything it knows.

Read/Post Comments (6) | Recommend This Article (9)

Comments from our Foolish Readers

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  • Report this Comment On September 27, 2012, at 11:13 AM, JimmyZangwow wrote:

    Despite the rhetoric of politicians, higher education is not (and should not) be an alternative for everyone.

    My local university spends millions on remedial training for enrolled undergraduates. There is something fundamentally wrong with a system that is OK with accepting applicants who don't possess the traditional qualifications of a college student (namely, literacy). Qualify yourself for college if you want to go, don't go with the expectation that you can finish what should have been mastered in K-12.

    Fortunately our state has tightened its pursestrings. When the federal level does so, reality will invade the realm of higher ed.

    Systems grow, bloat, and then collapse back to a sustainable size, and it will be so for higher education in the US.

  • Report this Comment On September 27, 2012, at 12:03 PM, PiratePrentice wrote:

    ...and for those of us that already have 100k plus in student loans? You're f*cked!

  • Report this Comment On September 27, 2012, at 12:15 PM, jsco427 wrote:

    I often interview and hire candidates for engineering positions within my company. There is no significant difference in the quality of education between expensive and prestigious universities and less expensive options.

  • Report this Comment On September 27, 2012, at 1:08 PM, TMFCrocoStimpy wrote:

    Dan, a very interesting read, especially on how you are laying out second-order effects. One question that always comes to mind for me, and I'd like to hear your thoughts (maybe another article?) is why having future income ripple through the consumer goods/services part of the economy is in some way healthier (from an economic standpoint) than to have that income flow through financial services? That is, why is buying something and increasing the $ going to some form of retail more beneficial than having $ going to a bank? From the individual standpoint there is an obvious reason, but from a high level economic standpoint which (if either) is preferable?


  • Report this Comment On September 27, 2012, at 7:45 PM, ColorMeSkeptical wrote:

    The rise in college tuitions in the U.S. share a lot in common with the recent real estate bubble: they are being inflated with _borrowed_money_ (Federal loans) that are being too easily doled out, thus distorting the market. It is a vicious spiral. More loan money makes consumers less sensitive to costs, allowing colleges to jack up tuitions and fees, which in turn creates demand for even more loan money. Something needs to be done to bring all of this back down to earth.

  • Report this Comment On September 27, 2012, at 9:59 PM, TMFGalagan wrote:

    @TMFCrocoStimpy -

    That's an interesting question because my proposed suggestions make the tradeoff more retail vs. educational institution rather than retail vs. bank. At some point, artificially high prices for education encourage oversupply of educational resources - pushing too many people into academia versus more valuable pursuits from a purely economic perspective.

    I'd argue in retail vs. bank, retail spending may stay in local economies longer than bank "spending," but that's admittedly an assertion unsupported by any research. Something to ponder.


    dan (TMF Galagan)

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