It Seemed Like a Good Idea at the Time: Student-Loan Forgiveness Programs are Making the Student Loan Crisis Worse

The federal government's student-loan forgiveness programs--like  Germany's decision to invade Russia in 1941--must have seemed like a good idea at the time.

After all, millions of college students are burdened by crushing student loans, the student-loan default rate creeps ever upward, and many college graduates have not gotten jobs that pay well enough to service their student-loan debt.

So why not create some programs that will lower student borrowers' monthly loan payments?

  And so the government created two programs that are essentially student-loan forgiveness programs. One program allows people who take public service jobs to make loan payments based on a percentage of their income for ten years. At the end of the ten-year period, the balance of their loans are forgiven.


Germany invaded Russia in the summer of 1941
It seemed like a good idea at the time.

The other program--income-based repayment plans (IBRPs) --allows borrowers to make monthly student-loan payments based on a percentage of their income for 20 or 25 years (there are several variations). Just as with the public-service loan forgiveness plans, student-loan debtors will see the balance of their loans forgiven at the end of the repayment period.

The attractiveness of these programs for student-loan borrowers is obvious. They see their monthly payments go down, which may keep many student-loan debtors from going into default.

Currently, about 1.3 million borrowers are enrolled in public-service loan forgiveness plans, and about the same number are enrolled in IBRPS. 

But here is the downside.  None of these programs contain provisions to discourage students from borrowing more money than necessary.  In fact--since the monthly payments are based on a percentage of borrowers' income and not the amount borrowed, the programs contain a perverse incentive to borrow as much as possible.  As a result, many of the people making income-based loan payments will never pay back even a portion of their loans.

Here are a couple of examples--one taken from a Wall Street Journal article and one taken from a New York Times story--that illustrate the problem.

Haley Schafer borrowed $312,000 to attend veterinary school in the Caribbean, even though the job market for veterinarians in the United States is terrible  Schafer got a job making about $60,000 a year, not nearly enough to comfortably pay back her student loans under the standard 10-year repayment plan.

So Schafer signed up for a 25-year income-based repayment plan that lowered her monthly loan payments to about $400 a month. Unfortunately,  her monthly payments aren't large enough to cover accruing interest on her loans.  The New York Times estimated that her loan balance will continue to grow, and when she finishes her 25-year repayment plan her loan balance will be more than twice the amount that she borrowed--$650,000!

And that's Haley Schafer's story. Now let's hear about Max Norris, a public-service attorney who borrowed $172,000 to go to University of California's Hastings College of Law.  Under the public-service student-loan forgiveness plan, he only pays $420 a month on his loan balance, not enough to cover accruing interest.

Norris's loan balance will be forgiven after 10  years. Assuming Norris stays in public service and gets annual raises of 4 percent, the government will forgive $225,000 in student-loan indebtedness--more than Norris borrowed!

In other words, the federal government is giving Morris a 100 percent subsidy to go to law school, even though the market is flooded with lawyers. In fact there are currently two law-school graduates for every new legal job.

Surely, anyone can see that it makes no sense for the federal government to permit people to borrow $100,000 or more to train people for professions that are already overcrowded and then allow them to make loan payments that are so small that the payments don't cover the accruing interest.

But that is what our federal government is doing.  

And, although these programs may help keep the student-loan default rate down, they are actually making the student loan-crisis worse.  Not only do we have 7 million people who stopped making loan payments and are in default, we have another 9 million who aren't making payments because they received an economic hardship deferment or are entitled to some other form of forbearance.  And then we have 2.5 million people who are making loan payments based not on the amount they borrowed but on their income, which means most will never pay off the principal of their loans.

In short--the number of people who will never pay off their student loans is in the millions--many, many millions.

References

Josh Mitchell. Student-Debt Forgiveness Plans Skyrocket, Raising Fears Over Costs, Higher Tuition. Wall Street Journal, April 22, 2014.

David Segal. High Debt and Falling Demand Trap New Vets. New York Times, February 23, 2013. Available at: http://www.nytimes.com/2013/02/24/business/high-debt-and-falling-demand-trap-new-veterinarians.html?_r=0

 

Let's face reality: The federal student loan program is not a problem; it is a catastrophe.

We reached those last days when we could endure neither our vices nor their remedies.

 

                                                                                    Titus Livy, on the decline of Rome

 

 

 

If Congress does not act, interest rates for the federal student loan program will rise to 6.8percent in July of this year. 

 

Last week, three Republican senators published an op ed essay in the New York Times suggesting what they think is a better way for setting student loan rates than the current system.  Senators Lamar Alexander, Tom Coburn and Richard Burr proposed that student-loan interest rates be set at the fluctuating 10-year Treasury rate plus 3 percent.

 

Keeping interest rates low for student loans is obviously a good thing for students. But let's face it, the student loan program is a catastrophe, and low interest rates for student loans won't fix this enormous problem.

 

First of all, although the federal government has never revealed the true default rate on student loans, evidence from many sources shows that it quite high. For students who attend for-profit institutions, the default rate over the lifetime of the repayment period is probably 40 to 50 percent.  Lowering interest rates is not likely to shrink the default rates--especially in the for-profit sector.

 

Second, income-based repayment plans, which are being pushed as a way to ease the burden on overstressed student-loan debtors, are making the default problem worse.  Lowering default rates will provide some marginal relief to former students in IBRPs, but it won't solve their underlying problem, which is that they borrowed more money than they can pay back.

Under an IBRP, students pay back their loans over a long period of time--20 to 25 years--based on a percentage of their income.  Any unpaid amount at the end of the repayment period is forgiven.

 

This may sound like a great idea, but this is the harsh reality:  A lot of student-loan debtors who participate in IBRPs, probably a majority of them, will never pay back their total loan obligations even if they make every loan payment on time.

Why? Because under an IBRP, the monthly loan payment will not be enough to cover accruing interest for many student-loan debtors. Thus, their debt will continue to grow even if they faithfully make their monthly payments.

 

A recent New York Times story illustrates this problem. The Times reported on a veterinary school graduate who borrowed $300,000 to attend a for-profit veterinary school in the Caribbean.  She obtained a job as a veterinarian--which is a good thing, and she is paying back her loans under an income-based repayment plan.

 

Unfortunately, her loan payments are not enough to pay back the accruing interest on her loans.  The New York Times estimated that the total amount of her debt will grow to $600,000 by the time her loan repayment obligations end even if she makes every payment on time!

 

Back when I was practicing law, my senior law partner told me I should admit my mistakes as soon as I realized I had made an error.  The longer I went without acknowledging my mistakes, my partner stressed, the bigger my problems would become. 

 

Over the years, I have found my former law partner's observation to be true 100 percent of the time.  The whole premise of the federal student loan program is flawed.  Over time it has grown into a $100 billion a year industry that has benefited colleges and universities but has hurt a lot of students. Total outstanding indebtedness is now over $1 trillion--making student loan debt the second biggest consumer-debt sector in  the American economy after home mortgages.

 

Fixing this mess won't be easy, and it will be painful.  But if we don't take drastic action, the federal student loan program (and the accompanying private student loan industry) will destroy American higher education. Indeed, it has already seriously undermined legal education.

 

What must we do? 

 

First, we must allow overstressed student-loan debtors reasonable access to the bankruptcy courts.  Let's face facts: most defaulting student-loan debtors are never going to pay back their loans, even if they are denied bankruptcy relief.  It would be far better both for debtors and the national economy if these unfortunate people were permitted to clear their debts in bankruptcy and go on with their lives.

 

Second, we must stop allowing for-profit colleges and universities to participate in the student loan program.  Even if all for-profit institutions were acting in good faith--and some of them are not--the default rate in this sector is simply too high to justify for-profit participation in the student loan program.

 

Furthermore, the U.S. has plenty of non-profit and public institutions to serve the needs of postsecondary students. In my opinion, postsecondary students would have plenty of good options for obtaining a college degree even if the University of Phoenix, Kaplan University and Capella University did not exist.

 

Finally, every college and university in the United States must be obligated to freeze tuition and fees at the current level as a condition of participating in the federal student loan program: and they must be further obligated to freeze salaries and benefits of their top executives.

 

President Obama, Congress, and the higher-education industry want to tinker with the student-loan problem, which is growing bigger every day. But lowering interest rates and encouraging students to go into income-based repayment programs will not fix this problem.  The solutions must be drastic, and they must be painful.

References

Lamar Alexander, Tom Coburn and Richard Burr. Playing Politics With Student Debt. New York Times, June 5, 2013, p. A21.

David Segal, High Debt and Falling Demand Trap Vets. New York Times, February 23, 2013, p. A1.