Why the Interest Rate Debate Doesn’t Matter

Michael Lux Bankruptcy Articles, Blog, Lower Payments, News, Student Loans 4 Comments

With federal student loan interest rates set to double July 1, there has been much debate over what should happen with the rate.  However, the real issues facing those with student loans continue to be ignored.

The news and discussion regarding the student loan debate reminds me of one of my favorite moments in Butch Cassidy and The Sundance Kid.  Butch and Sundance are on the run, and they are trapped on a high cliff overlooking a river.  Butch turns to Sundance and says, “lets jump.”  Sundance refuses, finally admitting that he can’t swim.  Butch maniacally laughs, “Are you crazy? The fall will probably kill you.”

Like the water below, the interest rates on Stafford loans are a real concern, but in the debate we have lost track of the massive cliff that we are overlooking.  In the case of student loans, there are actually three major problems that make up the cliff in which many Americans are perilously perched.  If the government really wanted to address the student loan debt crisis, they would focus on: 1) Lowering the cost of a college education 2) Helping reduce the aggregate student loan debt, and 3) Modifying bankruptcy laws to encourage responsible lending.

Problem # 1: The Rising Costs of College

A college education costs more now that it ever has before.  According the US Department of Education National Center for Education Statistics, the cost of a college education is nearly 600% more than what it was one generation ago (30 years).  Adjusting for inflation the average yearly cost of a college education in 1980 was $8,756.  Thirty years later the cost has nearly tripled to $21,657.

Not only has government funding for education dropped, but also the percentage of students attending college continues to grow.  The increased demand for education and the reduced support from the government equals significantly higher costs.

Problem # 2: Massive Existing Student Loan Debt

The total student loan debt in the US has jumped to over 1 trillion dollars.  That means Americans owe more in student loans than any other type of debt except mortgages.  Its been argued that this massive amount of debt is the source of the next great economic crisis.  Others argue that student loan debt is crushing the American Dream.

Regardless of the lens in which you look at student debt, it can’t be denied that for this generation of Americans, many are delaying things like marriage and home purchases.  Not only is this this bad news for the borrower who is forgoing many large purchases, but it is bad for the economy and the country as a whole.  The recent recession has created a situation in which many recent grads struggle to find jobs, and those that do find jobs often find themselves under employed.

There is no shortage of student loan horror stories.  Many of these borrowers are dealing with private lenders and their unforgiving terms.  Nearly all of the solutions proposed, including those by President Obama, do not address the problems of private loan borrowers.  For many, a slightly lower payment on certain loans is appreciated, but it is a drop in the bucket of a much larger and more substantial problem.

Problem #3: Bankruptcy Laws

While it is not impossible to discharge private loans through bankruptcy, it is exceedingly difficult and almost never happens.  Not long ago, student loans could be discharged through bankruptcy after a number of years passed since graduation.  The possibility of bankruptcy forced lenders to closely evaluate potential borrowers before approving financing for any loan.  Today, that is not a problem.  If a student defaults on a loan, the lender can garnish wages and collect.  There is almost no risk to student loan lenders.  Even the federal government managed to make a profit of 51 Billion Dollars on student loans.

The problems associated with the lack of bankruptcy protection are very similar to those that led to the sub-prime mortgage crisis.  Irresponsible lending puts the borrower in a position where it is nearly impossible to pay back their loan.  In the case of the sub-prime mortgage crisis, it led to a recession.  We have yet to see what will happen with student loans.

Arguments that say, “you took out the loan, you should accept the consequences” are not without merit.  However, they miss two key points.  First, bankruptcy laws in the US were created to give people a fresh start.  If you get in trouble with car payments, a mortgage, or credit card debt, you can file for bankruptcy and work your way back.  However, if you are saddled with too much student loan debt, there is no chance at a fresh start.  Second, lenders are in a far better position to evaluate the risks of a potential loan.  An 18 year old recent high school grad has no idea what their earning potential is, nor do they know the risks associated with student loans.  Lenders are in a far superior position to address these issues, but have no incentive to be responsible due to the dangers of bankruptcy.  Think about it this way, would a credit card company ever give an 18 year old a $30,000 line of credit?

Final Thoughts

If the Federal Government were to take action to address any of the above three problems, it would make a meaningful difference for all borrowers, future and present.  For example, if bankruptcy became an option, lenders would be encouraged to help borrowers find a way to pay back their loans.  Better yet, if the costs of college were lowered, less loan funds would be necessary, and the need for bankruptcy would be lessened.

Ultimately, passage of legislation lowering the interest rates can be helpful to many borrowers across the county.  But if your worries are limited to the Stafford Loan interest rates, you are only thinking about the water below.  Its time to think about the fall.