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Student Loans Need an Overhaul, Not Small Changes

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Student loan debt is the elephant in America’s living room, and with good reason. According to the most recent data from the U.S. Census Bureau and the National Center for Education Statistics, the average annual cost of tuition for a four-year school represented more than 40% of median household income in 2010.

That helps to explain why two out of three college students who are graduating with debt are doing so with an average of $25,250 in education loans plus another $4,100 in related credit card debt (per The Project on Student Debt and SLM Corporation, respectively).

Liabilities of this magnitude so early in a student’s life have the potential to diminish the quality of that life by crowding out many of the things we take for granted. Cash-strapped grads are delaying marriage and children, or even moving out of their old bedrooms at home, for that matter. They’re also putting off car and other major purchases, with obvious macro-economic ramifications.

And yet, we’re quibbling over interest rates instead of coming to terms with a problem that requires a great deal more than the plodding, incremental approach being taken by the Federal Student Aid office and congress.

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Free Credit Check & MonitoringFor example, while the government’s Income-Based Repayment Program is a decent starting point for addressing this crisis, it excludes private education loans, those that are already in the IBR Program or in ordinary repayment (for 2011 grads and older), as well as those that are currently in default—arguably the loans that should be addressed before all others.

By contrast, the Student Loan Forgiveness Act of 2012 (H.R. 4170) proposes to include older as well as private loans but, in the case of the private loans, only when total education debt (government and private combined) exceeds average household income for each of the previous three years. Also, it’s unclear whether or not defaulted loans would be eligible for consideration.

As for the “forgiveness” part, the government program requires 20 years of payments to reach that point as opposed to the 10 under H.R. 4170. The House resolution also ups the ante by proposing to forgive borrowers who’ve already paid in for 10 years.

With all of this in mind—and speaking as a former lender, student loan borrower and a parent of two kids who’ve made their own way through college and grad school—I’d like to suggest an alternate approach that has the potential to address the totality of the problem while distributing the pain a little more evenly. I say that because while I’m convinced that the schools, government and private lenders have all contributed to the making of this grand mess, students and parents are also responsible for their part of it.

[Related Article: On Student Debt Crisis, A Canary in the Mineshaft]

  • I believe that the government’s Income-Based Repayment Program should be expanded to include all loans without preconditions (i.e.; older, restructured, defaulted and private loans). The soon-to-be-implemented modifications to the discretionary income calculation would prevail, resulting in the potential for some level of loan loss on the part of the government and the private lenders, should distressed borrowers remain in the program for its duration.
  • The bankruptcy laws should be changed as well, to permit the discharge of private education loans. This would give the private lenders the proper incentive not to resist this workout program. It would also level the playing field somewhat—lenders that know that their borrowers have the ability to pull the plug (declare bankruptcy) are well motivated to find solutions, particularly when their loans are under-collateralized or, as it is in the case of education loans, where there is no underlying collateral.
  • The interest rate for these restructured loans should be no greater than for the subsidized Stafford program (3.4%). After all, this is a workout.
  • The maximum repayment term should remain at 20 years because anything less would unfairly reward those who borrowed the most.

Going forward, I’d also like to suggest that the government-sponsored loan program be modified as follows.

  • The Aggregate Loan Limit would be annually reset to a maximum of one times the then-current average salary for college graduates, which the National Association of Colleges and Employers reports as $42,000 for 2012. At today’s 6.8% government rate (Direct Unsubsidized), the monthly payments would equal 14% of that salary when the repayment term is 10 years, 11% when the term is 15 years and 9% when it’s 20 years.
  • The standard repayment term for all government loans would be set at 20 years. Unsubsidized borrowers should be encouraged (if not required) to pay the interest while they’re in school in order to avoid the compounding effect that would add to their obligation, while diminishing their ability to borrow under the program.
  • Rates would be indexed to the 10-year Treasury, plus a premium to cover administrative costs. (The 10-year Treasury approximates the cost to fund a 20-year, fully amortizing loan program.)

Consumers requiring additional borrowing may then decide to apply for loans from the private lenders, although with the change in bankruptcy laws that I’m advocating, that’s probably going to be tougher to accomplish. Consequently, I would expect students and their families to become even more frugal with their higher education dollars as they consider alternative school settings, degree acceleration and other cost-saving strategies.

I would also expect these moves to pressure the schools to rethink their cost structures, as they should.

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This story is an Op/Ed contribution to Credit.com and does not represent the views of the company or its affiliates.

Image: Mr. T in DC, via Flickr

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  • William

    In my opinion, your solutions do not go far enough. Not even remotely. Why would we allow dischargeability of private loans in BK when they only make up 15% of the problem? ALL student loans should be allowed BK discharge. After all, the government does not work with the borrower either.

    IBR is not a solution. It is a trap. When the government is borrowing at zero and charging even 3.4%, this is a travesty. Education is a social good, the government should EXPECT a loss. Not a profit. There are two generations of people impacted by this mess. These people are not stimulating the economy even though historically, this age-group has been the primary driver of our economy.

    • http://Www.mitchelldweiss.com Mitchell D. Weiss

      I hear you and agree when you say that education is in the national interest. However, whether or not the government has the ability to borrow at very low interest rates, the money that’s being used to fund these loans is being back-stopped by the taxpayers. That’s why I’m not inclined to advocate for discharge in bankruptcy. I’m more focused on the private lenders for this, whose loans account for 20-30 percent of the total. I counsel a fair number of students who are struggling with these private student loan debt. While the government charges 6.8 percent for unsubsidized Stafford loans, these students are paying 12 percent or more to the banks! When you do the math, a 12 percent loan has a monthly payment that is 25 percent higher than a loan that charges 6.8. That means that these students end up borrowing the equivalent of $12,500 for every $10,000 loan they enter into. And yet, these lenders enjoy the same protections in court. That doesn’t wash. As to your comment re/the IBR program, as I said in my article, it needs to do more than it is now. Student loans represent a national problem that requires a much more ambitious resolution than that which has been put forth by the government and the proponents of 4170.

  • William

    Without splitting hairs, I can assure you that the private loan market makes up only 10-15% of the market. If you want data, I will be more than happy to supply it to you.

    If your justification for the public student loan market is your interest in protecting the US taxpayer, and since you counsel people on these loans consider these few items:

    1. Allowing bankruptcy protections for FEDERAL loans would make the federal government think twice about lending to just anyone. If BK protections were added, the price of tuition would plummet because the easy money would disappear….since the lender would think twice in lending it to underwater basketweaving majors.

    2. When the federal government removed BK protections in late 1998, the price of college exploded 511% since 1999. This is not coincidental. In 2005, when private loans were made non-dischargeable, tuition exploded even more.

    3. The return of BK protections will force a lender to work with a borrower so the borrower does not file BK, private or federal. As if it is not obvious, the taxpayer would be protected. For the abuse myth: check out John Pottow’s paper (University of Michigan) on BK abuse and student loans. Signficantly less than one percent were filing BK on their student loans prior to removal.

    4. With BK protections, all other terms favorable to the borrower would return because again, the lender would have an incentive to work with the borrower, for fear of, you guessed it….the borrower filing BK.

    • http://www.mitchelldweiss.com Mitchell D. Weiss

      Thanks, William, I’d like to see the data to support the percentage. You can email me at mweiss@hartford.edu, if you like.

      I’ve looked at the Federal Reserve reports as well as data from other sources and have had difficulty triangulating on a credible figure. Even the numbers from a respected organization such as FinAid.org are estimated. My sense is that private education loans constitute more than 15% of the whole, but let’s set that aside for the moment to focus on the b/k issue.

      In my view—right or wrong—unsecured debt that carries a below-market rate of interest needs something extra to justify the price. Non-dischargeability in bankruptcy is, in my opinion, the quid pro quo for that consideration. That’s why I strongly believe private education loans that charge near-credit card rates do not deserve the protections that the government currently enjoys.

      That said, your comment inspires me to consider the possibility of two levels of pricing going forward—below-market/non-dischargeable vs. market/dischargeable—and let the chips fall where they may.

      As for the problem at hand, I’m still focused on a modified IBR approach for all of this debt—government, private, that which is currently in repayment, loans that are currently in default and so forth—priced at 3.4% which, as you correctly note, is positive to the incremental borrowing rate the government would incur at this time (between .7% and 1.59%, per Bloomberg, depending on the underlying term). If you were to do the math, the monthly payment requirements that would ensue are less than 10% of gross income—a very manageable level of indebtedness.

      • William

        Hi there:

        The data you requested:

        http://www2.ed.gov/about/reports/annual/2011report/fsa-report.pdf. Please see page 2 of the report (page 10 of the PDF) where, as of 09/30/11, the latest data from the federal government shows that 848 billion dollars of federal loans are outstanding. If you make the assumption that student loan debt had already hit one trillion dollars at that time (most sources stated that it was in early 2012) you see that the federal market makes up almost 85% of the entire student loan market. This September 2011 number does not take into consideration the additional federal borrowing over the last nine months. It does not take into account the fact that Chase and other banks have jumped out of the private student loan market. When you factor in that student loans had not reached 1 trillion in September 2011, that the last nine months of borrowing has been mostly federal dollars, and that those federal dollars are not included in the 848 billion, it is easily assumed that the federal loan market is much larger than 85%. Probably closer to 90%.

        I agree with you that Finaid.org numbers are estimated. They are merely Kantrowitz’s assessments….but he tries really hard.

        I do not agree with you that non-dischargeability in BK is a quid-pro-quo for “below market rates” because of the ability of banks and the government to borrow at zero percent coupled with the predatory nature of not having an “out” for the borrower in the form of BK as discussed in my prior posts. These are not below market rates, regardless of what Bloomberg says. The government should expect a loss on student loans simply because an educated citizenry is good for everyone, not just the educated individual. Job creation? Innovation? Educated voters? The link between greater education and less crime? All benefit society. Being indentured and unemployed does not.

        Why not make all student loans 2% fixed with BK protections and no capitalized interest…you know the terms the Baby Boomers had when they took out these loans? Refinancing abilities would be nice as well.

        About IBR: Have you really looked at it? You can drive a truck through the holes. The only time a borrower should consider IBR is if their only other alternative is default. The program is a “kick the can” down the road solution.

        This whole paradigm that private loans = bad and federal loans = good is a farce. Both are bad. The private loans are just slightly worse. This problem will not be solved until federal and private loans are revamped, protections are restored, and the CIC (College Industrial Complex) has skin in the game.

        FYI: BK and student loans. The BK abuse is a myth. You may have to pay for the full paper, but it is a good read.
        http://papers.ssrn.com/sol3/papers.cfm?abstract_id=967379

        Also, see studentloanjustice.org.

      • William

        Eight reasons why IBR is bad:

        1. The income forgiven is taxable. Who wants a tax bill in their late 50s or 60s on capitalized interest for money that was not borrowed? A non-borrower spouse would be liable for this tax bill as well.

        2. What happens if the borrower loses their job while on the program? A person needs to file a tax form with their student loan provider EVERY year. If a person loses their job in the middle of the year, how is this explained to the student loan servicer when all they really want to see is a tax form?

        3. The federal government is nearly broke. Plus, they have a history of changing the rules in the middle of the game. Who is to say that a future president will not cancel the program and make said cancellation retroactive? President Clinton retroactively removed BK protections on student loans in the late 90s so those who signed for their loans prior to October 1998 had their BK protections wiped away.

        4. What happens if the borrower gets a good job nineteen years into the program? Are they liable for the debt for an additional ten years? Are they kicked out of the program? Do they have to pay more? All answers point to yes. A person who actually earns more money later in their career may actually wind up paying more in the IBR program on capitalized interest for money they did not borrow. What happens if the borrower inherits money?

        5. It is hard to see 20 or 25 years into the future. Can you do it? I cannot.

        6. If the borrower is on IBR and the debt is growing, how are they going to explain that to a mortgage broker? The MB will see that debt and probably run away….the same with a student-debtor who applies for a credit card or car loan.

        7. It is hard to find answers to many of these questions. The DOE website is not clear. If you call them, they tell you to call your school. The school tells you to call your servicer, the servicer tells you to call the DOE. Questions are not answered because nobody knows.

        8. If a person is married and living in a community property state, their spouse’s income is counted for IBR purposes as well. Essentially, even if the debt were acquired before marriage, the spouse is on the hook for them as well. While there are only 9 CP states in the union, two of those states are Texas and CA…..65 million people. You don’t think that the non-debtor spouse, in finding out this information, is not going to be upset and/or that this fact will not have a negative impact on the marriage? Married filing separately results in the loss of many deductions (including the student loan interest deduction) so for many it is not feasible.

        • http://www.mitchelldweiss.com Mitchell D. Weiss

          Thank you for all of the good information, William. I’ll take a look in a bit.

          In the meantime, I accept the fact that we’ll probably remain at odds re/the B/K issue. I truly see it as a quid pro quo for below-market rates, but that’s just an opinion formed by experience.

          As for the rates that are being charged, the issue is duration. I referenced Bloomberg because I keep track of the yield curve. If the government were to borrow money today to fund receivables that are expected to span 20 years—which IBR loans could very well do—its cost would approximate the 10-year Treasury (longer discussion on how pricing is determined by plotting balances along a yield curve at a given moment in time). As such, the government would pay ~ 1.6%, to which it would have to add the cost of making and administering the loans over their term, as well as for the financial cost of payment delinquencies (more than 8% of student loans are currently past due) and losses (debts that are extinguished upon a borrower’s death when there is no parent-guarantor, or discharge, although the Brunner Test is reportedly nearly impossible pass).

          As such, the government’s “cost” in today’s market is not 3.4%, but it isn’t zero either. It’s also why I’m advocating for all of these loans to be worked out at the 3.4% rate that’s getting trashed at the moment. But that’s for another article on another day.

          With regard to the IBR program—another matter that will probably remain unresolved between us—what I attempted to communicate in my article (perhaps not clearly enough) is that I view it as helpful but not good enough. The eligibility requirements are too restrictive, the term is too long and the rate is too high.

          You raise a good point about the gain on the early extinguishment of debt. The current exemption expires at the end of this year, but this should only apply to loans that are disposed (resolved). Student loans that move into the IBR program have an uncertain future. Here’s why I say that:

          The fundamentals of the IBR are really no different than they are for any other loan forbearance—to the extent that amortization is deferred and/or interest is temporarily abated, there is ultimately a day of reckoning, unless, as it is in the case of the IBR program, there is a duration-cliff after which all is forgiven. Therefore, if someone were to apply for inclusion in the government’s program (which I hope will soon become more inviting), they’ll be bound by the terms of that arrangement for as long as they ELECT to participate. In other words, if they leave before the duration-cliff, they’ll owe whatever was deferred. Consequently, there shouldn’t be a taxable event. And, if they were to stay through the cliff period and be forgiven whatever unpaid balance they may have at that time, there WOULD be a taxable benefit, unless the current exemption is grandfathered.

          In any event, thank you once again for your thoughtful comments, William. I’ve enjoyed the dialogue.

          Mitch

          • http://www.mitchelldweiss.com Mitchell D. Weiss

            I just took a look at the Federal Student Aid Annual Report link you noted. Here’s the discrepancy—while the Operational Highlights indicate $848 billion in the government’s Loan Portfolio, this includes loans that were originated by the private lenders BEFORE the government took over the program. I say that because under the Financial Highlights section (which represents a combination of Balance Sheet and Income Statement elements), total assets (including the loan receivables) are $594 million, or ~ 70% of the $848 billion total, or roughly 65% of the aggregate balance of students loans (private and government) at that time.

          • William

            To your 8:27 comment.

            Even though the government did not originate those loans, as you correctly stated, they “took them over” or in other words, became responsible for them….which in my mind means that if they go bad, the taxpayer is on the hook. In theory they may have had a different source but in practice a default on one of these loans is as bad as a default on a government loan that was originated by the government.

            A few other things: please don’t be fooled by cohort default rates. Cohorts are just that: a snapshot that does not give the whole picture. If the government stopped using cohort default rates (I read somewhere that 2 year cohorts are no longer being used but now they are 3-year cohorts) you will find that the default rate skyrockets. My guess is nearly one third of all former student are not paying on their student loans. Why the government has a cohort default rate when people can defer for three years and forbear for another three on federal loans is probably the product of school lobbies in Congress. It makes no sense.

            http://chronicle.com/article/Many-More-Students-Are/66223/%29

            http://blogs.wsj.com/economics/2012/03/10/number-of-the-week-most-borrowers-not-paying-down-student-loans/

            About bankruptcy rights: I guess we can agree to disagree. As a professional who has years of experience representing creditors, I can tell you that the one thing that motivates a creditor to work with a debtor is the fear that the debtor will file BK and the creditor will get nothing. Again, I have years of experience dealing with this sort of situation.

  • http://www.accendomarkets.com Shirley Wright

    I feel that the amount of debt students end up with after studying for a degree or a masters is way too high. I agree with the fact that this sort of debt could cause students to stay at home longer, therefore putting off marriage and children. This all could have a major effect on the economic growth of the country. There is also the worry of finishing a degree and not being able to acquire a job in your chosen field.

    • http://www.mitchelldweiss.com Mitchell D. Weiss

      Good point about finding a job in a particular field. The message I’ve been communicating to students and parents is the strategic importance of having second and third options. Too many students make the mistake of marching down a singular path to the career they have in mind. What if that’s not in the cards? I remember speaking to an English major who was writing prospectuses for an investment banking firm in NYC. He took the job because there wasn’t anything available in his chosen field and also, as he put it, “Because finance guys can’t spell.” And just yesterday, I was interviewed by a journalist who writes for a major publication. I asked where he did earned his journalism degree. He hadn’t. His was a physics major. Thanks for the comment! Mitch

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