Student loan impact! Morgan Stanley: Repayment squeezes consumption, US GDP may decline by 0.1% this year

The U.S. student loan crisis is beginning to explode, which is not only a personal crisis but also a hidden danger for the U.S. economy.

On Monday, May 26, according to media reports, during the pandemic, the U.S. government paused federal student loan repayments for more than three years to alleviate pressure. Many people mistakenly thought this situation had passed, even believing they wouldn't have to repay since missed payments were not reported to credit agencies.

However, the reality is that this pause policy officially ended in the fall of 2023, and it wasn't until the fall of 2024 that overdue payments began to be reported to credit rating companies. Many people only realized the grace period had ended when they saw their credit scores plummet this year.

The consequence is a rapid surge in the default rate, with 5.6 million people suddenly starting to default in the first quarter of this year. The student loan default rate skyrocketed from 0.7% in the fourth quarter of last year to 8% in the first quarter of this year, returning to pre-pandemic levels. Morgan Stanley estimates that the addition of $10 billion to $30 billion in monthly student loan repayments will squeeze consumer spending, dragging down U.S. GDP by about 0.1 percentage points in 2025.

5.6 million suddenly overdue, credit scores plummet

In the first quarter of this year, the number of new student loan defaulters reached 5.6 million.

A report from the New York Federal Reserve this month showed that the student loan default rate soared from 0.7% in the fourth quarter of last year to 8% in the first quarter of this year, essentially returning to pre-pandemic levels, reflecting a large number of borrowers who are more than 90 days overdue and unable to repay.

The report also indicated that among the millions of new defaulters, 2 million originally had credit scores between 620 and 719, which are close to prime borrowers, while another 400,000 had scores above 720, categorizing them as prime borrowers. However, now, the former saw an average drop of 140 points in their scores, while the latter fared worse, with an average drop of 177 points.

This means they not only have to pay more each month to repay loans (which could have been used for food or rent), but they are also being placed on credit blacklists. Some individuals saw their credit scores drop directly by 140 to 170 points, and the severe cases cannot even get approvals for credit cards, auto loans, or mortgages, affecting their employment as well.

Due to the exit of two loan servicers during the pandemic, many borrowers did not even receive repayment notices. Many only realized they needed to repay when their credit scores plummeted.

The worst part is that the Trump administration has begun to reinstate debt collection processes this month, threatening to garnish wages, seize tax refunds, and withhold federal assistance for those who are overdue. Although collection procedures were standard practice before the pandemic, for those borrowers who have never experienced or have forgotten the harshness of it, this will still be a psychological shock.

Cambridge University economist Constantine Yannelis stated, "Imagine not having made payments for the past five years, and no one pursued you. Now suddenly you receive a letter from an unfamiliar company telling you, 'You still owe your previous student loans, and we are here to collect.'"

Yannelis is also concerned that Biden's previous push for large-scale student loan forgiveness led many to believe they wouldn't have to repay eventually, so they didn't include repayments in their budgets. The most dangerous group is the young people who graduated during the pause period; they have never experienced a repayment cycle and have not set aside a budget. Now, suddenly needing to repay, they have no idea how to cope. The default rate may inevitably rise further in the coming months, and more borrowers' credit ratings will continue to deteriorate

Consumer purchasing power is being squeezed, and the economy will also be hurt

This is not just someone else's problem; it is the simultaneous shrinkage of purchasing power for thousands of people.

Morgan Stanley economists estimate that this year's repayment amounts will collectively increase by $1 billion to $3 billion per month, and this expenditure squeeze on consumption could lead to a 0.1 percentage point reduction in U.S. GDP in 2025.

Morgan Stanley further points out that the situation may worsen, as about 8 million borrowers are participating in the SAVE plan (income-driven repayment with lower monthly payments) from the Biden era, which is facing legal challenges. Many may not start making actual repayments until the end of this year or early next year, and the risks are still ahead.

Who is most at risk? The most vulnerable groups bear the heaviest burden

Media reports indicate that those most affected are students attending two-year or for-profit schools, or those who dropped out without obtaining a degree. They face a higher risk of default, and these groups often overlap and are in a more precarious economic situation.

Data from the New York Federal Reserve shows that, for example, in Mississippi, 45% of student loan borrowers are in default, the highest rate in the nation. This state is also one of the states with the highest poverty rates in the U.S.

Lesley Turner, an economist at the University of Chicago, states that those caught in the student loan repayment crisis are often the least able to bear the burden, rather than the stereotypical "22-year-olds attending Ivy League schools and living in coastal areas."

Therefore, this student loan turmoil is not a punishment for luxury education, but a warning bell for grassroots families trapped in a credit quagmire