Interest, fees and penalties are burying millions of student-loan debtors--not the amount these poor people borrowed to go to college

Sometimes, huge problems can be analyzed best by simply boiling down the complexity of a situation into a simple phrase.  For example, "It's the economy, stupid," crafted by Democratic political strategist James Carville, summarized a central theme of Bill Clinton's 1992 presidential campaign.

Likewise, we can summarize at least one huge element of the student-loan crisis by focusing on one core fact: accrued interest, penalties and fees are burying millions of student-loan debtors, not the amount of money these poor people borrowed to attend college.

For example, I have a friend on the East Coast who borrowed a total of about $55,000 to obtain a bachelor's degree and a graduate degree; and he paid nearly $14,000 on those loans.  Unfortunately, my friend suffered a series of unfortunate life events--health issues, divorce, and job loss.  Now at age 67, he is living entirely on Social Security and a small pension. The Department of Education is garnishing his meager retirement income, and he is living on only $1200 a month.

A few weeks ago, my friend filed an adversary complaint in bankruptcy court, seeking to discharge his student-loan debt based on the Bankruptcy Code's "undue hardship" provision. Guess how much the government says he owes? $120,000--including accrued interest and $23,000 in collection costs. That's more than twice the amount my friend borrowed.

And this case is not atypical. In Halverson v. U.S. Department of Education, Stephen Halverson borrowed about $132,000 to obtain two master's degrees. Just as with my East Coast friend, life happened for Mr. Halverson: a job loss, serious health issues, a divorce, medical expenses for a child, and expenses incurred to care for an aging parent.

At times, Mr. Halverson was unable to make payments on his student loans, but he obtained a series of economic hardship deferment, and he was never in default.  Nevertheless, when Halverson was in his 60s, it was clear he could never pay back his student loan debt. By the time he filed for bankruptcy, his total deb had ballooned to almost $300,000--more than twice the amount he had borrowed. And Mr. Halverson's job at that time only paid $13.50 an hour.

Various public-policy analysts have argued that there is no student-loan crisis because most people borrow relatively modest amounts of money--typically about the amount of a car loan. But these analysts ignore two key facts:

1) Even a small student loan is a huge burden for someone who doesn't have a job or who has a low-income job.

2) People who are unable to make their monthly loan payments must obtain an economic hardship deferments or enter a long-term repayment plan in order to avoid default. And both options mean that the debtor's loan balance goes up due to accruing interest.

Thus we see people like Liz Kelly, featured in a recent New York Times article, who owes $410,000 on her student loans, far more than she borrowed to attend college and graduate school. Today, at age 48, the annual interest cost on her indebtedness is more than the entire amount she borrowed to obtain her bachelor's degree!

And I know a man in California who borrowed around $70,000 to finance his education, and paid back about $40,000. Now the Department of Education claims he owes more than $300,000, including a one-time penalty assessed in the amount of $59,000! That one penalty is more than 80 percent of the entire amount he borrowed!

Surely it should be apparent to everyone--even Secretary of Education Arne Duncan, President Obama and Congress--that adding interest, fees and penalties to people's student-loan debt only increases the likelihood of default.

The higher education industry and the Department of Education have embraced economic-hardship deferments and long-term repayment plans because both programs hide the fact that millions of people can't pay off their student loans.

Does anyone think, for example, that Liz Kelly, who was unable to pay back the $25,000 she borrowed to get an undergraduate degree, will ever pay back the $410,000 she currently owes.? Does anyone think my East Coast friend, who is living on about $1,200 a month, will ever pay back $120,000?

Like a seething volcano about to erupt, pressure is building on the federal student loan program. Currently, about 41 million Americans owe a total of $1.3 trillion in outstanding student loans. Let's face it: at least half that amount will never be paid back.

References

Kevin Carey. (2015, November 29). Lend With a Smile, Collect With a Fist. New York Times, Sunday Business Section, 1. Accessible at: http://www.nytimes.com/2015/11/29/upshot/student-debt-in-america-lend-with-a-smile-collect-with-a-fist.html?_r=0


Halverson v. U.S. Department of Education, 401 B.R. 378 (Bankr. D. Minn. 2009).

Like a Secret Drunk Who Hides A Bottle of Bourbon in His Office Drawer, The Higher Education Industry is Addicted to Student Loans But Won't Admit It

Almost everyone agrees that Alcoholics Anonymous has the best treatment program for alcoholics. AA's simple 12-step program is followed by alcoholics all over the United States, and AA's method for treating alcoholics has been adapted for other addictions as well--including the addiction to drugs.

Perhaps the higher education industry should adopt an AA-style 12-step program to treat its addiction to the federal student loan program.  After all, higher education's dependence on federal student aid money really is an addiction. For-profit colleges in particular could not survive a week without regular infusions of federal cash.

Drinking problem? What drinking problem?
photo credit: twentytwowords.com

But the Obama administration and Arne Duncan's Department of Education treat the student-loan mess as if it were just an irritating  problem and not a full-blown crisis.  It's like Aunt Sally's tolerance for Uncle Ed's drinking binges--she just smiles while reassuring herself that Ed maybe drinks just a wee bit too much.

And President Obama's announcement to expand the Pay As You Earn program shows us that he is in denial about the magnitude of the student-loan crisis.  His administration's decision to expand the program, like its decision to continue strengthening the regulation of the for-profit industry, shows that President Obama and Arne Duncan know that the student-loan mess is serious.  But they want to address the problem like Aunt Sally deals with Uncle Ed's drinking--they just want to water down the whiskey.

Let's face it, in spite of the New York Times' sycophantic praise, Pay As You Earn is nothing more than a plan to stretch students' 10-year student-loan repayment obligations to 20 years.  Yes, this will reduce borrowers' monthly payments, which will give college-loan debtors some short-term relief; but borrowers will be paying on their loans for a majority of their working lives. Is that a real solution?

Second, although I haven't seen any financial analysis to back me up on this observation, I suspect a lot of people who elect the government's income-based repayment options for paying back their loans  won't be making payments large enough to reduce the principal on their debt.  When their loan obligations are discharged after 20 years, millions of people will still owe as much as they borrowed. How can that be a good thing?

So let's look at that 12-step plan.

Step number one is to admit that you have a problem and are powerless to control it.  The Feds could follow that first step by releasing the real student-loan default rate--not that phony three-year rate it releases every October.  According to DOE's latest report, about 15 percent of  recent debtors defaulted within three years of beginning their loan repayment phase; for students who attended for-profit colleges, the rate is 21 percent.

Those numbers are bad but they dramatically understate the true default rate.  Many for-profits, community colleges and some traditional four-year schools have hired so-called "default prevention" firms to contact distressed student borrowers and encourage them to sign up for economic hardship deferments.  Students who obtain these deferments--which are quite easy to get--are not counted as defaulters even though they are not making loan payments.

Just facing up to the reality of how many millions of people are not paying back their loans would be an admission that the student-loan program is out of control.  That's step number 1 of the AA's 12-step plan.

Another important step in AA's 12-step program is to make amends to the people you have injured. I believe that is step number 9.

And of course the Obama administration, Congress and the nation's colleges and universities haven't made amends to the people who have been hurt by the student-loan program.  And until they make amends they haven't done what is necessary to break the higher education industry's dependence on federal student aid money.

What should be done?  As I have tirelessly advocated, Congress needs to amend the Bankruptcy Code to allow insolvent student-loan debtors to discharge their  student loans in bankruptcy so long as they file in good faith.

Second, the federal government should stop garnishing the Social Security checks of elderly student-loan debtors who defaulted on their loans.

And third, the for-profit college industry needs to be shut down.

Of course none of these things are going to happen.  Our government will continue to hide the true magnitude of the student-loan default rate, and it will continue to let millions of people suffer who have no reasonable hope of ever paying off their student loans.

And just like Uncle Ed, who drinks in secret, our nation's colleges and universities will continue abusing students by forcing them to borrow more and more money.  Eventually, Uncle Ed will kill himself from excessive drinking. And eventually, higher education's addiction to federal student aid will destroy the integrity of our nation's colleges and universities, which were once the envy of the world.

No one knows just how Uncle Ed will die--liver disease or a fatal car accident.  And no one knows just how low American higher education will go in terms of its degradation.  But the future is bleak for both of them.

References

Student Borrowers and the Economy. New York Times, June 11, 2014, p. A20.

Workin' for the Man: President Obama's Disasterous Plan to Expand Income-Based Repayment Programs for Student Loan Debtors

Tomorrow, President Obama is expected to announce an expansion of his "Pay as You Earn" income-based repayment program for student loan debtors. This program,  which Obama initiated by executive action in 2011, allows student-loan debtors to pay roughly 10 percent of their income on their loans for a period of 20 years.  (The exact formula is a bit more complicated that.)  At the end of the 20-year repayment period, any unpaid loan balance will be forgiven.



Passing the student-loan mess on to the next president

Pay as You Earn is popular with student debtors because it is more generous than the other income-based repayment (IBRP) options. One major program requires debtors to pay 15 percent of their income over a period of 25 years.

But a lot of student debtors don't qualify for Pay As You Earn under present regulations. According to the New York Times, Obama plans to extend eligibility to an additional 5 million student-loan borrowers, including those who took out loans before October 2007. 

Is Pay As You Earn a good thing for the nation's distressed student-loan debtors. Yes it is--at least in the short term. For people struggling to pay mountains of debt under the standard 10-year repayment plan, Pas As You Earn will lower monthly payments substantially.  People who are currently paying 15 percent of their income under a 25-year IBRP will be delighted to switch to Obama's more generous Pay As-You Earn program.  People who are unemployed or underemployed will be particularly grateful, because if their income falls below the official poverty level, they won't have to make any monthly payments at all.

Is there a down side to Pay As You Earn? You bet.

First of all, all the income-base repayment plans remove all incentives for student borrowers to limit the amount of money they borrow. If their loan payments are based on their income and not the amount they borrow, then there is no reason not to borrow as much money as you can.

Second, Pay As You Earn and other IBRPs do nothing to slow the burgeoning cost of going to college.  Colleges have no incentive to keep their costs down, because they know students will simply borrow more money to cover tuition hikes.  What do colleges care if their graduates are making student-loan payments for 20 years?

Third--and most significantly, these long-term repayment plans are going to fundamentally change the way Americans view postsecondary education and the world of work. There was a time when low-income individuals worked their way through college, graduated with no debt, and entered the workforce determined to buy homes, start families, and begin the confident climb up the economic ladder.

Now, 18- and 19-year olds are going to begin college knowing that they will pay for their postsecondary education by donating some percentage of their income to the federal government over the majority of their working lives.  In essence, they will become indentured servants for the government--sharecroppers if you will.

I think this arrangement will foster cynicism among the young, because they will realize on some level that they have been forced into unreasonable levels of indebtedness because colleges refuse to control their costs. They will see university presidents like NYU's John Sexton make outrageous amounts of money while they sign up for long-term college-loan repayment plans that they will not pay off until they are in their 40s and 50s.

And, since they won't have to pay anything under Pay As You Earn if they are unemployed or live below the poverty level, I think many of them will postpone going to work. Many will figure that it makes sense to travel or take low-wage jobs in exotic locales rather than seek more remunerative employment. And the incentive to work "off the books" will increase, because people in IBRPS who enter the cash economy will not only avoid paying taxes and making Social Security contributions, they will avoid making student-loan payments as well.

Moreover, once these college-going young people figure out that their payments will be based on their incomes and not the amount they borrow, they will borrow as much as they can.

I appreciate the President's efforts to provide overburdened college-loan debtors some immediate relief by offering plans to lower monthly loan payments while extending the loan repayment period. Unfortunately, in the long run, the results will be catastrophic.

In reality, President Obama is simply passing the student-loan mess on to the next president to deal with.  Millions of people may see their student-loan payments go down in the short-term, but they will be significantly extending the length of their loan repayment period. Most Pay-As-You-Earn participants --I predict--won't be making loan payments large enough to cover accruing interest  or pay down the principal on their notes--which means they won't really be paying their loans back at all. 

And meantime--total student-loan indebtedness--now more than $1 trillion dollars--will continue to grow and grow.


References

Jackie Calmes. Obama Plans Steps to Ease Student Debt. New York Times, June 8, 2014, p. 17.