Solving The Student Loan Crisis
You may have heard that presidential hopefuls Bernie Sanders and Elizabeth Warren have plans to cancel student loan debt and make college free.
Let’s dive into this challenge that has reached existential levels for many of the 40+ million Americans who collectively owe $1.5+ trillion (with a t). If you think the bank bailouts of 10 years ago were fair and fun, then you’ll love what is looming to resolve the student loans crisis.
The Current Student Loan Situation
Before discussing solutions, keep in mind the following:
1. You can’t discharge student loans in bankruptcy, even if you’re bankrupt.
Since 2005 changes to the bankruptcy laws, borrowers, with rare exceptions, are unable to discharge or reorganize student loan debt in a bankruptcy proceeding. A history of student loans and bankruptcy eligibility is here.
Because of this unfair exception, student loans, along with the fees and penalties that accumulate from missed payments, follow borrowers to their graves. This can lead to garnishment of wages, tax refunds, and Social Security benefits, as well as low credit scores, and the inability to borrow for other purposes. There is no escape.
2. Income-dependent repayment plans options are too complex.
The default repayment option for federal student loans is a standard 10-year term; however the borrower can opt for an income-dependent repayment plan that can make these payments affordable.
Unfortunately, there are many different plans with different rules about:
- the percentage of your income that is used to determine your payment
- how long the payments last
- how marital income is treated
- whether your industry qualifies for special treatment
- which federal loans qualify
- whether the loan write-off that occurs at the end of the repayment plan would be treated as taxable income.
This unnecessary complexity has metastasized into a monster. Good luck trying to figure out what is best for you or trying to get unconflicted and accurate help from your loan servicer or college financial aid office. You’re on your own.
3. The interests of colleges conflict with borrowers.
Imagine a Lexus dealer that could offer a car loan for the full price of any car to anyone who walked into the showroom. The dealer doesn’t need to run a credit check and is off the hook if the loan is not repaid. They’d sell a lot of cars!
That’s the deal colleges have. They broker federal and private loans to their students and then are immediately paid in full. The colleges have no “skin in the game” as to whether the loan is ever repaid or even if the student (or parent) has the means to do so. The college gets the money and the student gets the loan balance.
4. Borrowers — i.e., students and parents — have little political power.
Politics is rarely about fairness and justice. It’s about power and in this fight, that resides with the colleges and financial institutions who benefit from these loans and prefer the status quo. That’s a formidable challenge if you want to solve this problem in a way that gives borrowers a chance to re-emerge from their debtor’s prison.
Potential Solutions to The Student Loan Crisis
To paraphrase Will Rogers, “If stupidity got us into this mess, how do we get out?” We can’t simply leave things as they are as millions of Americans are being slowly suffocated by these loans with no resolution in sight. But any solution will be a fight and not feel equitable to everyone.
Any sensible student loan recovery plan should address these points:
1. The federal government should incent states to offer an affordable 4-year college option to qualified students.
One option would be for the federal government to finance the 4-year cost of a state college education, if the state agreed to cap its fees at that level (excluding room and board). In this case, that federal funding would be an income-dependent loan to the student. College would not be free but it would be affordable with the ultimate cost born by a combination of the student, the federal and the state government. An illustrative example may help.
Currently, the federal government offers up to ~$30,000 in federal student loans for an undergraduate (plus Pell grants in some cases). Let’s imagine the feds increased that support to $40,000 for the full cost of an undergraduate education as long as the state did not charge any more to the student (excluding room and board). The state would receive $40,000 and the student would incur an income-dependent loan of that amount.
If the state did not agree to these terms, the amount of available federal loans would be reduced. Private colleges could opt-in for the same terms, if they chose to do so. Students would pay back this loan over 15 years on an income-dependent basis.
2. Re-enable a bankruptcy option.
Bankruptcy is not a gift — it is a traumatic experience and rarely means a full discharge of all debts. In most cases, the debts would be reorganized into an affordable payment. Our society moved beyond debtor’s prisons and this is the process we’ve chosen to sort out debts to give people a fresh start. Let’s use it.
The result would be dramatic. For new borrowers, lenders wouldn’t offer loans to students whom they thought would be a high repayment risk and thus students would be unable to borrow beyond what was repayable.
Existing borrowers would have the option of a bankruptcy filing. In most cases, they would not get fully released from these obligations but instead the court would reorganize the debts into an affordable payment plan. Just the threat of bankruptcy would make lenders willing to negotiate a reasonable adjustment.
3. Ensure colleges are on the hook for future loans that they broker to their students.
Colleges must have some skin in the game for loans they initiate. The practical effect of this would be that colleges would be reluctant to encourage more borrowing and more sensitive to a student’s ability to repay. If a student could not afford that college, the college financial aid office would be less likely to push them to take more loans.
4. Standardize income-dependent repayment plans into a single option available to all student borrowers.
Create a single income-dependent repayment option. For example, instead of the various 5-, 10-, 20-, and 25-year repayment plans currently offered, let’s settle on a single 15-year term that is tied to 10% of income. Also, make it the default option, instead of the standard 10-year repayment plan.
It took us a while to get into this mess and it will be a challenge to dig out. Maybe Sanders or Warren have the best plan, but any way forward will be a food fight with powerful interests who prefer the status quo. Too many lives are frozen in debt purgatory to allow this absurd system to continue as is.
Update: The New York Times weighs in again with how absurd and complex the loan forgiveness program is.