A few days ago, the New York Times criticized Secretary of Education Betsy DeVos for rescinding a Department of Education directive forbidding student-loan debt collectors from gouging borrowers who default on their student loans. Under President Obama, DOE directed the debt collectors not to assess 16 percent penalties on defaulters who quickly agreed to payment plans that would bring their loans back into good standing.
The Time is right to Criticize DeVos. As the Times pointed out in its editorial, student borrowers in the government's direct student-loan program are now defaulting at the rate of 3,000 a day. It is unjust to assess penalties against defaulters that far exceed the administrative cost of bring defaulted loans back into good standing.
But the Times rebuke went off the rails when it touted the virtues of long-term income-driven repayment plans for distressed debtors. The Times cited allegations that the lenders were not telling loan defaulters about "affordable" income-driven repayment plans (IDRs) that might cost borrowers as little as zero a month.
The Times is simply wrong to tout IDRs as "affordable." It is true that people who enter these plans may only be obligated to make token payments and perhaps no payment at all if they are unemployed or live below the poverty line.
But many people in IDRs are making monthly payments so small that the payments do not cover accruing interest. Thus their loan balances grow larger with each passing month. People in 20- and 25-year repayment plans will find they owe much more than they borrowed when their payment obligations come to an end.
It is true that the unpaid portion of their loans will be forgiven for people who successfully complete these IDRs, but the amount of the cancelled debt is considered income by the IRS. Under current IRS regulations, the only people who can escape that tax bill are people who are insolvent at the time the debt is forgiven.
Does that sound affordable to you?
The pitfalls of IDRs are illustrated in Murray v. Educational Credit Management Corporation, a 2016 bankruptcy court decision out of Kansas. The Murrays borrowed $77,000 in the 1990s to get undergraduate and graduate degrees, and they consolidated their debt in 1996 at 9 percent interest. Over the years, they made substantial payments. According to the bankruptcy judge, they paid $54,000 on their loans--about 70 percent of the amount borrowed.
But the Murrays' loans were put into deferment for some period of time when the couple could not afford to make their monthly payments. Meanwhile, interest accrued, and by 2015, their $77,000 debt had ballooned to $311,000--four times what they borrowed!
ECMC argued that the Murrays should be put into an IDR. The most generous plan called for monthly payments set at 10 percent of the Murrays' adjusted gross income. Their monthly payment would then be only $635 a month, quite manageable for a couple whose joint income was approximately $95,000 a year.
But the bankruptcy judge rejected ECMC's proposal. The judge pointed out that interest was growing at $65 a day--around $2,000 a month. Thus, the Murrays' monthly payments would amount to less than half of the monthly accruing interest. The Murrays' debt would grow to well over half a million dollars over the 20-year repayment period.
Thus, if the Murrays signed up for a 20-year IDR, one of two fates awaited them: either they would be faced with an enormous tax bill or they would be so broke their tax liability would be extinguished on the grounds of insolvency. In any event, the Murrays would be in their late 60s and in no financial shape to retire.
The Obama administration promoted IDRs and even rolled out new ones: PAYE and REPAYE. These plans give struggling debtors short-term relief, but a majority of the people who sign up for an IDR will never pay off their student loans.
Almost 6 million people are currently enrolled in one IDR or another, and most are not making payments large enough to cover accruing interest. Although IDR enrollees are not technically in default, few will ever pay back their loans.
What is the solution for these people? There is only one solution: a discharge of their loan obligations in bankruptcy. DOE will not admit this stark fact, and neither will the New York Times. But the bankruptcy courts are beginning to figure out that IDRs do not provide the "fresh start" that the bankruptcy process is intended to provide.. We should look for some blockbuster bankruptcy court decisions in the near future as the judges wake up to the charade of IDRs.
Editorial, The Wrong Move on Student Loans. New York Times, April 76, 2017.