plan B on student loan forgiveness for all

Eight Alternatives to Student Loan Forgiveness for All

Michael Lux Blog, Opinion 0 Comments

The hot political debate right now is whether or not student loan forgiveness for all borrowers is a good idea.  Presidential candidates Elizabeth Warren and Bernie Sanders both have released plans for forgiveness, and it appears the issue will be a factor in the 2020 election.

I think that all student debt should be forgiven.  I have six figures of student debt, so I will be the first to admit I’m biased on the issue.  That all being said, higher education finance has been a mess in the United States for a long time.  Tuition prices have exploded out of control, consumer protections are almost nonexistent, and many borrowers have been duped by predatory colleges, lenders, and “relief” agencies.  Wiping the slate clean and starting fresh is probably the best answer.

Unfortunately, I think the proposed forgiveness for all is unlikely to happen.  These campaign promises will not be altering my repayment strategy.

Even if mass student loan forgiveness doesn’t happen, there are plenty of things the next President of the United States can do to address the student loan crisis.

Return Bankruptcy to Student Loans

The current bankruptcy rules are great for student loan lenders, but they make little sense when compared to other debts.

If an individual tries to start a business and it fails, or gets into too much credit card debt, they have the option of bankruptcy to pursue a fresh start.

For those not familiar, bankruptcy is a difficult process that can have lasting negative consequences.  However, it provides a much-needed path to a clean slate for individuals who otherwise might not have any hope.

Bankruptcy could also help get outrageous college costs under control.  Lenders will be more likely to loan money to a student who is at a good school with strong job placement numbers.  Lending money to someone attending a lousy school with a poor job placement program would be very risky because these borrowers would be more likely to need bankruptcy.  Right now, lenders know they are getting paid no matter what, so they have little incentive to help borrowers make smart borrowing decisions.

The sad part is that lenders are in a great position to access the value of a school or degree program.  Arguably, they are in a better position than students.  Changing bankruptcy rules could help steer students into more in-demand jobs at better and more affordable schools.

Let Borrowers Pick Their Loan Servicer

This a small change that could make a big difference for student loan borrowers.

The concept here is pretty simple.  If the many federal student loan servicers had to compete to get borrowers, they would have a huge incentive to provide better service.  Right now, borrowers have almost no say in who services their loans.  If a borrower gets assigned to Navient, FedLoan, or any other servicer, they cannot just change to a different servicer.

With no incentive to provide high-quality customer service, loan servicing companies simply focus on maximizing profits.  If we let capitalism and the free market work, lenders would have a substantial financial incentive to make things better.  If they don’t improve, they lose customers.

The wonderful aspect of this change is that it would cost very little to put into place.

Make Forgiven Debt Tax Free

The government has already made some progress on the forgiven debt tax issue.  In the past, if a parent borrowed loans for their child to attend school and the child died, the Parent PLUS loan could be forgiven.  However, the forgiven debt was treated as taxable income by the IRS, leaving the grieving parent with a huge tax bill.  Fortunately, this particular issue has been fixed… but temporarily.

Borrowers who are on an income-driven repayment plan and have their debt forgiven after 25 years currently need to plan for a large tax bill.  Such a tax bill makes little sense.

The general rule of taxing debt seems logical because it helps prevent tax fraud.  If my employer loans me $10,000 and then forgives the debt after I have worked there for a period of time, that forgiven debt should be treated as income.

In the case of student loan borrowers with forgiven debt, it makes little sense to treat the forgiveness as income.  We already don’t tax Public Service Loan Forgiveness, and the Warren and Sanders plans would similarly not tax any forgiven debt.

Fix Income-Driven Repayment

Income-driven repayment plans are excellent in theory, and they do help many student loan borrowers.

The problem is that enrollment can be difficult.  Loan servicers have a huge incentive to steer people away from income-driven repayment, and borrowers have to take extra steps that could easily be avoided.

For starters, instead of requiring a borrower to submit an income-driven application each year, have them submit an open-ended application.  The open authorization would allow the IRS to send updated income information each year, and the Department of Education can adjust payments as necessary.

We also have a ton of different repayment options available.  Creating one new plan with the best features of all the exiting plans would be much less expensive than student loan forgiveness and still make a huge difference in the lives of borrowers.

Finally, let’s make income-driven repayment the standard repayment plan.  Right now, the first actual student loan bill that most borrowers get is based upon the 10-year repayment plan.  This large monthly bill can scare many people into delinquency or default because they mistakenly think they cannot afford to pay their student loans.

Let Employers Help Pay Down Debt

Many employers are already using student loan assistance programs to help recruit potential employees.

The government could encourage the expansion of these programs by making student loan assistance tax-advantaged.  It could work similarly to how employer-sponsored 401(k) plans currently work.

Support for this change is growing as many large employers want to add this benefit.  It has already been discussed in Congress and has a good chance of becoming a reality.

Letting employers contribute to student loan payments also has the benefit of being very logical.  In most cases, the student debt was incurred to prepare the employers for the job they currently work.  If employers require education, they can help employees pay it off.

Expand the Government Student Loan Database

The Department of Education has detailed records on all federal government student loans. Borrowers can log into the National Student Loan Data System and find loan balances, interest rates, and servicer information.

Private loans are a different story. Borrowers looking for loan and lender information can run their credit report, but because not all lenders report to all creditors, the information may be incomplete. This can lead to borrower confusion.

Confused borrowers miss payments, and they are vulnerable to fraud. If the government expanded the existing database to include private student loans, borrowers would be better protected, and lenders may have an easier time collecting the debt.

Hold Colleges Responsible for Borrowers who Don’t Make Payments

College accountability sounds simple in theory, but it can be complicated in practice.

In the current higher education financial system, colleges have to meet very minimal standards to keep receiving federal student loan money.

If colleges were on the hook for debt that didn’t get repaid, they would have a huge incentive to help students find jobs and to make sure they were prepared as they entered the workforce.  Such a system might also be the end of predatory for-profit colleges.

If colleges had skin in the game, the price of school might more accurately reflect the value of the degree.  It would be a win for all students.

Let Borrowers Refinance Federal Loans

Federal student loans have higher interest rates than many private loans.

Borrowers considering refinancing have a tough decision.  They can get lower interest rates, but they lose the protections that come with federal student loans like income-driven repayment and student loan forgiveness.

In many cases, the interest rate that a borrower must pay doesn’t reflect the risk of default on the loans…. all borrowers are treated equally.  If low-risk borrowers could stay with the federal government, the federal government might make more money on student loans.

If the government wanted to help borrowers, they could stop charging interest or charge the low-interest rates that banks currently enjoy.  The idea that the government currently profits from many student loan borrowers seems wrong.

Looking Past Student Loan Forgiveness For All

Wiping the slate clean on student debt would be amazing.

If political circumstances make the goal impossible, there are many alternatives that can still make a massive difference in the lives of student loan borrowers.