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.
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.
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.
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?