How Uncle Sam became the biggest student lender

Courtney Miller, usatoday.com; see also "While university presidents earn millions, many professors struggle."

(Photo: Thinkstock)

After mortgages, student loans represent the biggest debt being shouldered by U.S. households. Americans owe $1.21 trillion in student loans — that's an average of $47,712 for each household in debt, according to a new study by NerdWallet. Over 70% of this debt is owed to the federal government, making Uncle Sam the largest holder of nonrevolving American consumer debt, with $932 billion owed to it.

It hasn't always been this way. As recently as the third quarter of 2009, auto loans and credit cards outranked student loans in terms of their burden on American households — and the federal government held just a small part of that debt. The federalization of most education loans and the rising cost of college, which has outpaced inflation for decades, are among the reasons for this surge of money owed to the U.S. government.

How we got here

During the recession that began in 2008, capital dried up, making loans harder to obtain, according to the U.S. Department of Education. To ease the impact on student borrowers, the federal government began to purchase guaranteed student loans — loans issued by private banks, but for which the federal government assumes the risk for default — under the Ensuring Continued Access to Student Loans Act. Then, in 2010, the federal government ended programs that guaranteed private loans altogether, instead issuing loans directly through the Department of Education, making the federal government the most popular lending option.

Federal loans are different

While private loans are still available, they are no longer backed by the government and thus command a higher interest rate. Lower rates, along with other generous repayment terms such as forbearance, deferment and the potential for debt forgiveness for nonprofit and public sector workers, make federal loans a more attractive option for students who qualify.

These repayment options can make a big difference, says Abbey Stauffer,NerdWallet's student loans expert.

"Federal borrowers can go on income-based repayment plans, which base one's monthly payment amount on income, whereas with private loans, there's much more rigidity around your payment amount. When you're a recent grad scraping by a living, keeping your monthly payment low can be a godsend," she says.

"The reality is that many students need a blend of both federal and private loans to fully cover their college costs. We recommend maxing out federal loans first, then shopping around for private loans that offer the best terms," Stauffer adds.

Also keep in mind that despite their benefits, federal loan options like forbearance and deferment can have unforeseen consequences for borrowers, allowing interest to accrue over longer periods, which will drive up balances.

Ways to keep student debt under control

Stauffer recommends that borrowers first explore income-related repayment plans, under which the borrower continues to make smaller payments including interest, to keep federal loans under control. These programs include Pay As You Earn, income-based and income-contingent repayment programs.

You can explore switching repayment plans on the government's Federal Student Aidwebsite. If you decide it's right for you, talk to your loan servicer, who can help you make the switch.

Another option to keep debt down is work-study, which allows students to take mostly on-campus jobs in lieu of or in addition to student loans. These jobs, along with federal loans and grants, are awarded based on need, so students need to fill out the FAFSAin order to be eligible.

The legacy of student loans

It's difficult to discharge student loans in bankruptcy — although federal loans offer deferment, forbearance and debt forgiveness options to help make your debt more manageable. But because the full responsibility of the loan squarely remains on the borrower, this debt can follow Americans into their retirement.

Borrowers still default, though, with the most recent number from the Department of Education placing the default rate for federal student loans at 11.8%. That's significantly higher than the 2.7% default rate for private loans.

All this debt will have an impact for decades to come, and it won't be limited to those who did the borrowing — the entire economy will see the effects. High student loan payments will mean more people won't be able to afford to buy a home or other big-ticket items.