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The Solution to the Student Loan Debt Crisis

Michael Lux Best Of, Blog, News, Student Loans 14 Comments

Problem Abstract: Much of the national discussion regarding student loan has centered on one type of federal loan. A broader approach is necessary.

Goals: The price of college has escalated out of control and needs to be reined in. Borrowers and lenders alike need to be more responsible when it comes to student lending. Finally, people with no hope of ever paying off their student loan debt need to be helped.

Solution: Create a special distressed borrower status to provide a road to recovery for people with extreme student debt issues and to encourage responsible lending and reasonable college education pricing.

Our Trillion Dollar Dilemma

Any plan to address the trillion-dollar student loan crisis must address three major issues facing the college lending process.

Issue 1: The cost of college continues to grow much faster than the rate of inflation. If any solution is to truly make an impact, there must be a means for lowering the price of a college education.

Issue 2: Americans owe over one trillion dollars in student loan debt. As a nation our student loan bill is higher than our credit card bill.

Issue 3: There is presently no incentive for lender responsibility. Just like the sub-prime mortgage crisis, people are being given loans without understanding how difficult it will be for them to pay them back. Because bankruptcy is nearly impossible, lenders have no incentive to help borrowers manage their debt.

Much of the proposed legislation being discussed in Congress deals only with Federal Stafford Loan interest rates. Though a lower interest rate will aid some borrowers, it does not make college any more affordable. In fact, by making loans more affordable or easier to get, it actually makes paying for college easier. When its easy to pay for college, schools can continue to inflate the price of an education. Of all the people who are struggling with student loans, the hardest hit are often those with large private loans. Adjusting the interest rate on Stafford loans will not assist these individuals.

The Challenge to Any Change

Passing legislation in today’s political environment is extremely difficult. Private lenders hold over 100 billion dollars worth of private loans and each year these balances grow. Corporations running for-profit colleges are making large fortunes. The considerable financial and lobbying influence that these two groups have over Congress cannot be ignored. Furthermore, given how fiscally conservative the House is at this time, any solution cannot be prohibitively expensive.

A Real Solution

Factoring in the problems of the current system and the political climate, the Sherpa’s Comprehensive Student Loan Reform would call for the following:

  • All borrowers will have the right to apply for distressed borrower status. Distressed borrower status would affect both private and federal loans the same.
  • Distressed borrowers will make yearly financial disclosures to their lenders for determination of income and payment ability
  • Distressed borrowers should be required to spend no more than 35% of their income in excess of the poverty level on student loans.
  • If a borrower owes multiple lenders, the 35% of their income allocated to student loans will be distributed to their lenders in proportion to their total debt.
  • If a borrower makes a good faith effort to comply with all of the rules of distressed borrower status for a period of ten years, they will be eligible for bankruptcy discharge on their loans.
  • Lenders cannot make any negative reporting to any credit agency about a borrower who complies with the terms of distressed borrower status.
  • Colleges will be required to provide both lenders and students detailed information regarding graduation rate, job placement rate, and salary statistics.
  • Statistics will be made available to students and lenders regarding the number of former students: in distressed borrower status, delinquent on their loans, and in default.

A Prudent Compromise

The point of this plan is not to make everybody happy. This plan is designed to be a common sense solution that will get the system working again.

If you are someone who has over $100,000 in private loan debt, this plan will likely be somewhat of a disappointment to you: 35% of your income is a bunch of money, interest rates will still be high, you will have more paperwork if you apply for distressed borrower status, and any help in the form of bankruptcy is at least 10 years away.

If you are a lender, you also will have some complaints with this plan: you issued those loans knowing that bankruptcy was almost impossible, you probably are not thrilled about a new law adjusting what you can collect. The last thing you want is any change to a system that is allowing record profits for you.

Even though this legislation will leave many unhappy, it creates a framework to encourage responsibility in the marketplace. It also helps to facilitate a dialogue between lenders and their borrowers. By increasing the level of knowledge of market participants, the system can operate more efficiently. The goal is not to make things easy for anyone nor is it to prevent people from making money. It’s about fundamental fairness for all parties involved in student financial aid.

Possible Tweaks

Most of the percentages suggested are merely to serve as example numbers. Further analysis will be needed to determine optimum numbers.

The point of distressed borrower status is two-fold: it is to help the people who have been hit the hardest by the student loan crisis and it is to put lenders on notice of those individuals who are doing everything they can to honor their commitments. One possible adjustment would be to create a mechanism for borrowers to enroll in a voluntary garnishment program. Lenders would like that because it would guarantee that they are getting their 35% right away and it would discourage people from applying for distressed borrower status. Borrowers might also like the fact that they no longer have to think about their student loans, but it would feel like a hefty pay cut. If a borrower subjects themselves to this sort of system for 10 years, there should be no debate as to the burden that their loans have created and their deservingness for bankruptcy protection.

One thing that cannot be tweaked with the Sherpa plan is this law applying to federal loans and private loans. Too many people are struggling with private loan debt for it to go unaddressed. Furthermore, if we are to realize any of the goals such as lower tuition and more responsible lending and borrowing, it must apply to all forms of student loans.

The Advantages

Whether or not you consider the student loan crisis to be the death of the American dream, it cannot be debated that student loans are devastating many people. No American should have their life defined by their struggles with student loans. Nor should any financial decision made at the age of 18, no matter how imprudent, haunt someone for the rest of their life.  These issues are addressed with the Sherpa plan.

Economic Advantages

By giving people a chance to repair their credit, many student loan borrowers will be better equipped to purchase a house, a car, or get a job. There is a huge economic benefit to getting this large, young, educated portion of our society back in the market.

Advantages to Future Students

The price of college will better reflect the value of the education provided. At present, most lenders are largely indifferent about the quality of the educational program a prospective borrower is pursuing.  They don’t care if it is a Harvard business degree or an associates degree at a for-profit institution with a 40% job placement rate. No matter where the borrower goes, lenders know they can collect this debt. If the debt is even the slightest bit more difficult to collect, lenders have an economic incentive to put more focus on things like job placement statistics, expected salary, etc.

If an 18 year old who is trying to pick between a number of colleges, walks into his or her bank and asks about student loans, the following dialogue could ensue:

Prospective Student: Banker, I’m working on funding my college education, what sort of loans and rates could you offer me?

Banker: Well, Prospective Student, it depends on where you plan on going to school and what you are going to study, what schools were you thinking about?

Prospective Student: I’m looking at schools A, B, and C.

Banker: If you go to school A, depending on your credit, we can offer a rate as low as 4%, at school B the best we could offer you would be 8.5%, but for school C we likely won’t be able to offer you a loan.

Prospective Student: Why are the rates so different?

Banker: School A has great employment statistics and their graduates very rarely fail to repay their debt. School B is not quite as good, their graduates seem to be able to find jobs, but the expected income is low relative to how much they charge. School C loans are a bad investment for us because so many students who go their fail to repay their loans. Their job placement numbers are very week.

Prospective Student: That’s really useful information. Thanks!

If discussions like the previous hypothetical were to take place schools would have to competitively price their programs, AND they would have a much larger incentive to help their graduates find quality work. Schools would be encouraged to discontinue practices like spending 10 times more on recruitment than on job placement for graduates.

Helping Current Borrowers

By applying for distressed borrower status, borrowers would put their lender on notice that they are struggling with their loans and that the 10-year countdown towards bankruptcy protection has started.

Currently, lenders have little to no incentive to work with their borrowers. If a borrower cannot keep up, the lender simply can garnish wages while the principal on the loan grows. The lender makes a fortune and the borrower has no recourse.

If the Sherpa plan were adopted, borrowers would benefit financially by adjusting terms to aid borrower repayment. Because neither the borrower nor the lender want to deal with bankruptcy, the two parties would have motive to work together to find a solution that works. When borrowers and lenders are working together, with better information, everybody wins.


The debate about whether or not there is a student loan crisis in this country is over. The only questions remaining are how bad is it going to get and what will be done to fix it. People are struggling with their loans and they need help, or at the very least, they need a reason to believe that there is a light at the end of the tunnel. By incentivizing responsible lending and borrowing, and by encouraging lenders and borrowers to work together, we can create a system that helps the economy rather than dragging it down.


What do you think should be done to solve the student loan crisis?


  • Well done Michael. We need to come up with some solution and I like this. If there was more responsibility in the lending arena, then we could control the type of loans that are given and to whom. They are throwing around money just like before the housing bubble popped. They only do it because they know that most people cannot dissolve the loan.

    • Thanks Grayson. I’m glad to see that you are noticing the similarities between the two situations. Hopefully this gets addressed sooner rather than later.

  • Things to consider:

    1.) 35% might be a bit high for high debt borrowers. Perhaps this can be reflected as a weighted percentage based on a borrowers debt load.

    2.) I think there is an opportunity to pay student loans pre-tax. This can make the world of difference for borrowers. The challenge is pushing legislation through to make it happen.

    3.) Under the distressed borrower plan, there should be an interest rate reduction for X# of successful payments.

    Thanks for putting this together! Looks great, let me know how I can help.

    • Andrew, I really like your ideas. I’ll address them in order:
      1) I agree that 35% might be two high, but I used that number just as a starting point. However, I think its important that people be contributing a decent size portion of their salary. I’d like to have this plan and the option of bankruptcy apply only to those who really need it and deserve it.
      2) Paying student loans pre-tax is a fantastic idea. I’d love it if Congress would get behind that idea. My only fear would be that it would cost too much to get passed.
      3) I like the rate reduction idea as well. Hopefully, lenders will do this on their own accord, b/c they want their borrowers to have a realistic chance of paying off their loans. My ultimate goal is to create a system were lenders and borrowers work together, if it doesn’t happen, this could be a great idea for phase two.

  • Many countries around the world offer free or incredibly inexpensive education to local students. Those countries are the ones growing and surpassing us in educating the best engineers, competent doctors, and scientists. Imagine what this country could do with free education in positions with great career potential.

    • A free education would be great. Unfortunately, too many people with too much influence are getting rich in the current system. Its to bad we can’t just act for the greatest good of the country.

  • I think this is a good starting point for fixing the system. I remember signing my student loan paperwork. I had no idea what I was really doing. I never thought about having to pay back that money or how much it would even be. Then as a senior, I received the paperwork telling me that 6 months after graduation, I was to pay X dollars per month. That was a surprise. It wasn’t fun, but luckily I was able to pay them off.

    • Jon, I was the same way. I was embarrassed at how little I knew when I graduated. Its hard to get people to understand this before they start school. That’s why I think there should be a little more responsibility on the lender side of the equation.

  • The cost of education is indeed crazy high in the US and access to credit for things other than tuition should be drastically scrutinized. In the UK your boss has an obligation to deduce a % of your first salary to repay your student loans. The % is determined by the government depending on your salary. I think it is great because it is taken from your gross and mandatory, so you never miss it when you get your first paycheck.

    • That is really interesting. Do you know how people in the UK feel about that system?

  • The entire system here in the US is out of whack. The reality that an 18-year old can sign up for a loan that financial strap a person for years, have no guarantee of ROI on what the loan is for, AND be hard to discharge in bankruptcy is simply crazy. As a parent, I look to the future with both eyes wide open.

    • Its good that you have both eyes open to this situation. Things will never change until enough people realize that we have a serious problem on our hands.

  • The problem is much deeper than just the interest rates!!
    thought the rate is important!

    The most important problem is how the interest is calculated!

    07/07/13 2-loans total $132.15 monthly payment this month…………only.. $10.98 when to Principle!!
    while…. $121.17 when to Interest!!!!

    Here’s a better one 12/07/12 payment total payment $131.52
    Principle $1.51……. while the Interest was only $130.01!!!

    I live in Louisiana during Hurricane season there is a law enforced on price gouging is this any different?

    • I think these examples really illustrate the point that just paying the minimum will take forever to get the loans paid off.