Who’s to Blame for Federal Student Loan Defaults?

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In the course of rolling out new content as a part of insideARM.com’s feature series, The Student Loan Issue, (brought to you through a generous sponsorship by F.H. Cann & Associates) you’re likely to read a lot about student loan debt tied to borrowers who can’t repay, won’t repay, don’t repay, or for whatever reason simply haven’t repaid their financial obligations to the U.S. Department of Education or private lending institutions of one kind or another.

And there are a whole mess of folks who fall into one of those four categories.

In fact, almost five and a half million Americans are behind on their student loan payments. To put that number in perspective, 30 of the 50 U.S. states have total individual populations less than 5.4 million according to the 2010 Census.

For few moments, however, I’d like to shift your attention to a different group of people with student loan bills to pay. Yes, people who are, by definition, still debtors–but distinctive in that, at present, they’re making payments. People (to cite an example close to home) like me.

First, allow me to give you a brief rundown of how I came to write this–and what, exactly, this is really about. Yesterday afternoon, Philadelphia-based tax genius and (much more prolific) co-contributor of mine on Forbes.com, Kelly Phillips Erb (also known by her superhero alter ego @taxgirl on Twitter) wrote an excellent article, Why Does Congress Love Houses More Than Students?, about incongruities in the U.S. Tax Code when it comes to incentives for buying ugly, over-sized houses crammed onto tiny, treeless parcels of land versus investing in one’s education.

Ms. Erb’s exceedingly sharp–in both senses of the word–commentary is bolstered by a straightforward analysis of how current U.S. tax laws reward buying stuff (i.e. real estate) but dispirit investing in ideas (i.e. the future). In short, she argues that Congress is “making it harder for the middle class to go to college. But we’re making it easier to buy a house.”

Ms. Erb’s blog ends with two particularly cogent and compelling paragraphs. She writes:

“Somehow, we have decided, as a society, that it’s more important to own a flat in Manhattan or a McMansion in Fulton County than it is to have a college education. That is what we decided, right? Because that’s what Congress seems to think (for a history of the student loan interest deduction, check out this prior post).

I’m not a fan of creating tax incentives to solve or encourage behaviors. But the fact is, we do just that all of the time. We do it to kickstart the housing market, to encourage spending and to target hiring. If we’re going to accept that tax incentives are used to drive behavior, what better behavior could we seek than encouraging students to pursue an education? Why have we seem to have decided that investing in houses (as well as stocks and bonds) should be more tax-favored than investing in education? And more importantly, what does that mean for our children?”

I’d like to extend Ms. Erb’s position and suggest that it in fact overlaps a related question about federal policy related to student loan debt collection and student loan delinquencies under the Direct Loans program. To do so, I’ll now bring this conversation back to my own experience. I funded parts of my private undergraduate and public graduate school education with subsidized federal student loans. As previously noted, my loans are currently in repayment (and will be until I’m joyriding in a Hoveround electric mobility scooter). But as Ms. Erb explains in her post, for many borrowers faithfully paying down their loan balances each month, the maximum annual interest deduction for these obligations is capped at $2,500. Buying a house or two? Under current rules you can deduct up to $1.1 million of the interest on your loans.

Yet even that whopping $2,500 student loan interest deduction comes with a significant catch. As a married couple filing jointly, if your combined income is greater than $150,000 you cannot claim a student loan interest deduction; the individual taxpayer ceiling is even lower. But surely there are limits on home loan interest deductions? Nope. No caps whatsoever related to filing status or income. Zero. Nada. Zip. Which is, to use my example, precisely the amount of the annual student loan interest deduction I am allowed to claim–even though my monthly student loan bills fall somewhere in a range between making a mortgage payment and leasing a 2012 Porsche Panamera Hybrid.

I’m not whining about my student loan payments. I’m well educated, and I understand that growing my brain came at a price I chose to pay. But when one considers that ED’s Default Division reported late in 3Q2011 that its portfolio was sized at $33.5 billion, I just have to ask a question: how many federal student loan borrowers currently in either default or delinquency status might be helped if they were allowed under federal tax laws to deduct a greater percentage of the interest they pay on these loans? And by “helped” I mean: how many more of them might in fact wind up in repayment rather than delinquency or default?

In this narrow context, I don’t wish to debate the economic value of a college education versus that of propping up a beleaguered U.S. housing market. My concern is focused squarely on the massive delta between a $2,500 interest deduction cap and another cap almost 500 times that. It’s there, to use a Twainesque metaphor, that the path of least resistance is what makes the river crooked.

 

Michael Klozotsky is the Chief Content Officer at insideARM.com. He doesn’t drive a Porsche.

Continuing the Discussion

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  • avatar Jerry Ashton says:

    Your piece should more appropriately be titled: “Is there a way to ameliorate student loan defaults” as it is much more positive than simply placing blame.

    “Kloz” and “Erb” do a good job at identifying peripheral ways to prune back the debt. Still not dealing with the roots, but I am sure they will be tended to in future articles.

  • avatar DONALD DALY says:

    Without the taxpayers assistance in obtaining the education that places those in higher income levels, and enabled those consumers that willingly borrowed under a clear set of terms, the income to buy the Porsches and $1,000,000+, homes it wouldn”t have happened and they’d be driving a Chevy and living in an average house. This kind of nonstop nonsense in reaching for more freeies on the back of the middleclass taxpayer is proof positive of the need for tax reform and hopefully a flat tax system.

  • avatar Govtmule says:

    Stafford loans cap at $57,000 for undergrad, avg interest rate of about 5% (combine subsidised and unsub rates) = max annual interest of $2850. Between the cap on stafford loans and interest deduction it seems like a reasonable nudge from Uncle Sam to keep a lid on student loan debt. Given that these are unexperienced consumers (for the most part) with little certainty for their post college incomes and expenses this seems like somewhat sensible govt policy (this is coming from raging libertarian who borders on anarchist). We can already see that the runup in debt is causing problems for both the lenders and the students why would you want to remove a disincentive to borrow more?

  • avatar Brian says:

    Stafford loans are at 6.8% last I looked, thought the subsidized loans were half that until the rate was scheduled to double this summer.

    The ROOT of this serious epidemic is deep and complex.

    Of course there is significant responsibility bestowed on the borrower, in most cases kids ranging from 17-22 years old. They’re older once the loans become due, but at the time of commitment most of these borrowers are pimple faced teens that lack education about credit to make wise decisions before they sign on that dotted line. Many end up with horrible private loans whose interests rates are akin to charging their education on credit cards.

    To make matters worse, most of these “kids” do not know how to budget the money they’re borrowing, and end up overspending on things that have nothing to do with getting an education. If you were ever in college you know the things I’m referencing. Hand a 17 year old kid a $5,000 check, and faced with tuition and books costing less than $2k, I know where the rest of that money tends to go..

    Now they got their money and spent it, and look forward to the next “check” they’ll get so they can keep up their independent lifestyle of choice, and perhaps buy a new laptop and a nice pair of sneakers.

    How many of these kids do you think pay the accruing interest on the loans while they’re in college, so that once they graduate the loan isn’t recapitalized and start the never ending process of compound interest?

    The banks are eager to keep this market going because they’re making money hand over fist, the loans are near-if-not-risk-free because there is no statute of limitation and the loans cannot ever be discharged in bankruptcy, and there is a long line of kids lined up in the “system” to sign on the dotted line so they too can get their share (and their “guaranteed” education).

    Is the government thrifty with the costs to manage the loans?

    Anyone working the DOE contract knows it’s a GOLD MINE because of how it works.. Rehab an account or x number of months by setting up 1-2% monthly payments, and VOILA, DOE gladly pays your commission based not on actual cash you collected, but on the rehabbed balance.

    The roots go much deeper too..

    Sure, borrowers should be held responsible. But when a system takes advantage of the poor, uneducated and young, don’t we have a responsibility to correct the system and protect those who can’t protect themselves from bad decision and making poor choices?

    Remember, about 1/3 of all student loan borrowers never graduate and gain the financial benefit of having a degree.. A large percentage borrow tens of thousands for degrees from less-than-desirable institutions of higher learning, and the current economy certainly does not guarantee anyone a good paying job enabling the borrowers to begin their lives and be able to repay what they borrow..

    Do people feel STRESS when they over borrow and create debt?

    What does that STRESS do to the mind of a young person attending school to “learn”?

    What we’re missing is EDUCATION about how it all works PRIOR to having these “kids” commit themselves to things that make their lives harder down the road, with or without a degree. Education about Budgeting, Credit, Debt and basic money management.. These topics are not covered in High School but should be mandatory in every economics class and a cornerstone of a young adult’s educational experience.

    This post is not about blame, it’s about not taking advantage of our youth for the sake of making a buck. There’s too much money in student loan lending and our institutions of higher learning, and it’s all being made off the backs of our youth any which way you slice it.

  • avatar CoSigner says:

    On the same topic…I am the co-signer on my ex-husband’s $250,000 private student loan balance. There are 8 private loans in total, which paid for his BA and his law degree. (No federal loans) He rents a room in a house and I live in an apartment. Due to these loans, we both have credit scores in the 520 range. We hardly qualify for a credit card, let alone real estate. 2 of the 8 loans were sold to a collection attorney, who is now threatening to report him to the ethics committee and revoke his law license if he doesn’t start paying more than the $700/mo which is being auto deducted from his paycheck. This does not include the additional $900/mo which he’s paying for on the remaining 6 loans AND the increased interest rate on 3 of the loans come July. I was left with the measly $50,000 credit card debt, which I’m paying off for the next 5 years. We are MAXED out. We’ve attempted MULTIPLE consolidations with and without co-signers and do not qualify due to our credit scores. His loans have gone in and out of default for the last 3 years and we can’t find anyone to assist us in this mess. Sadly, I realize we are not the only ones facing this incredibly frustrating problem. He wants to pay his loans, but can not afford the $1,800/mo payment. Education is a gift and a privileged; however it was not meant to debilitate you for the rest of your existence. Had we known then what we know now, regardless of divorce, we never would have continued his education.

  • avatar Mike Bevel says:

    All of these comments are compelling and fascinating and entirely the reason why we were so excited about this particular Big Issue.

    The intersections of finances and education and expectations and responsibility create this glorious mess of a gray area. I hope this conversation continues.

  • avatar George Pickett says:

    The amount of interest you can write off on your tax return has nothing do with why there are so many defaulted college loans in my opinion.My experience over the last 19 years working in the student loan industry. The reasons I feel you have such a high default rate is as follows. The schools aren’t working with students to steer them towards a degree in a profession that is strong or growing. Alot of students can not get a job in the choosen field they received a degree for. Students don’t read the information given to them when registering for school that explains how forbearance’s or deferments work. These are form’s that can be obtained from their lender or the servicer of their student loan or loans to postpone their payments. And the lender and servicers of student loans aren’t taking the time to explain to borrowers how forbearances and deferments work or how many months they are allowed. I have also heard some borrowers say the school they attended promised job placement and that was a false promise. Also most of your lenders or servicers don’t spend a great deal of time skip tracing accounts trying to find the borrowers current address. You would be surprised at the amount of loans that default simply because the borrower didn’t update their address. The student loan industry could be cleaned up. Borrowers aren’t making their student loan payments because of the aount of interest they can write off on their tax return.

  • avatar George Pickett says:

    Those where really good comments by Brian. And he is correct in the fact that the responsibility falls on the borrowers. I agree that young people should be guided when deciding to go to college. And years ago schools used to do that. But now education is just a business and the bottom line is making money. But that is also part of our society and peer pressure so to speak. Years ago a degree would almost guarantee you a better living and good paying job. That is not the case now or in the recent past.

    I need to make a few corrections to his article. The only time you have to pay the accuring interest on your loans while you are at least a half time student is if you have unsubsidized loans. With subsidized loans the government pays the accuring interest. The current fixed interest rate on a stafford loan is usually 6.8%. The varible interest rate is currently at 2.36%. Private banks haven’t given out new student loans since 7-1-2010. That is when the federal government took over all aspects of student loans (Direct loans).

    But once again the younger borrowers or students need to grow up a little. The majority of student loans can get up to 36 months of forbearance to postpone the payments. And it says right on the form the nterest is still accuring and will be capitalized and added back into the loan if not paid in full before the forbearance expires. But the majority of borrowers don’t seen to care and they don’t pay the accuring interest. Which means the principle goes up and so does your dailey and monthly interest.

    And I don’t know how the USDOE contract works in regards to defaulted student loans and rehabilitation? But this is a good program for the most part. Because when you default and that is reported to the credit bureuas. You are given or have an I9 put on your credit report. Which is the worst you can get and it reduces your credit score by roughly 200 points. That’s more than likely why COSigner and her ex have such a bad credit score.

  • First, let me thank everyone for continuing this discussion in the comment thread. We appreciate all of the perspectives you’ve shared here.

    One thing I’ve noticed in the ongoing conversation is the absence of much talk about the disparity in the Tax Code between mortgage deductions and student loan deductions. One might address it as a fundamental question of fairness, though of course that’s a loaded term. On the other hand, I personally believe there are potential delinquency implications (or default aversion opportunities) were either income restrictions or caps on total deductions (or both) lifted.

    For example, imagine a given borrower has X amount of federal student loans and Y amount of private student loans. Assuming he or she could deduct a greater amount (or any at all–as I suggested from my own experience in the original post) of interest on federal loans, this would inherently free up some amount wallet share that could be diverted to paying down the private loan balance which may fall under a higher interest rate, etc. Moreover, those extra dollars might instead be used to pay credit card balances and prevent delinquencies for those lenders. Or that extra cash as a result of a higher deduction amount may be pumped back into the larger U.S. economy (this is one of the tenets of Ms. Erb’s Forbes.com blog) through consumer spending.

    If you accept that argument, I think it at least complicates the picture of a student loan debt “crisis” in America. And I think it makes a pretty strong case for why in the ARM industry, student loans as an asset class are an important market to watch, even if your company doesn’t work that paper.

    Thank you again for reading insideARM,
    Kloz

  • avatar Brian says:

    Michael – unfortunately the average student loan borrower doesn’t give a rat’s azz about whether or not they can write off the interest. Most of them don’t have “write offs” because they don’t own their homes and most are taking the standard deduction.

    The borrowers that I am referring to, are making $20-40k/yr, and you know what that gets you in life? About $1200-$2600/month net to live on.

    Good “student loan suicide”, “how to pay off tuition” and other such terms.

    Students are resorting to suicide, prostitution/stripping, drug running and all sorts of stuff in order to get by and try to pay for their education.

    There are only two ways out of a student loan – pay it or die. Student loans will haunt you for the rest of your life unless you’re fortunate enough to NOT have borrowed a small fortune and got on top of it quickly.

    The subsidized “low interest” loans you hear about are a joke. Most students are paying 6-7% interest on the low side, more often than not much more. Skip a month and see what happens, the penalties and fees accrue like a barrage of Floyd Mayweather punches to the jaw.

    I borrowed a tiny $3,500 in college and paid $70/mo for more than 10 years.

    Imagine that number multiplied by 10 and you’ve got a good average today.

    The average college graduate these day also has more than 4 credit cards and around $4,500 on those, 15% owes more than $7,000 on those cards.

    If you are old enough to have gone to college in the 70s or early 80s you’re probably the last batch that got through without falling prey to the banks bribing you.. Free t-shirts and key chains in exchange for you filling out a credit card application and promptly “winning” the opportunity to go out and start charging beer and pizza on your new plastic card.

    These kids are doing it, and their parents don’t know about it.. If you have a kid in college right now I can almost guarantee you that (s)he owes thousands of dollars that you don’t know about.. It’s one of the new “taboo” topics on campuses, kids don’t tell their parents, and surprisingly they don’t even tell their peers about their debt..

    It’s a real travesty, and a modern epidemic that we have to address..

    These kids aren’t all “the other kids”, they’re YOUR kids, and they’re getting into deep debt right now..

    You can tell a lot of a society by how they treat their young and down trotten..

    Student loan debt has surpassed consumer credit card debt, it’s said be over $1,000,000,000,000 (yeah, that’s trillion). Unlike consumer credit card debt, this debt will NOT disappear by itself.. Unlike consumer credit card debt this type of debt does not afford the borrower much due process..

    I speak to kids about money, debt and credit, so yes, I’m slightly passionate about it, and just a tiny bit pissed off at the system.

    :)

    PS – send your teenage high school kid down to the financial aid office and see what they advise, or in what direction they send your kid.. My bet is on the “counselor” pulling out a FAFSA form and telling your kid, “this is where you start”.. Cause you can go to school anywhere you want, there is plenty of money available..

  • avatar Brian says:

    I mean GOOGLE those terms.. not GOOD..

    I also intended to elaborate on why most students don’t care about the tax deductions, but you probably got the gist of my post.. haha

    Sorry, not pointing any fingers, but talking about taking tax deductions just isn’t relevant to most of the borrowers that I am referring to..

    PS – stress activates natural cortisol in the brain which inhibits learning new information and accessing information already learned.. Isn’t that ironic, that we put so many of these kids under tremendous stress right at the start of their most important learning, but just expect them to cope.. It’s inhumane and contradicts common sense..

  • Brian–

    You’ve said a lot. I’d like to respond with just a few comments.

    You write: “Students are resorting to suicide, prostitution/stripping, drug running and all sorts of stuff in order to get by and try to pay for their education.” I will tell you, I taught at an R1, Big Ten university from 1997-2006 and remain closely connected in many ways to a lot of folks in the academic community. I can assure you that the sentence I quoted above, if it is valid at all, should begin “A very, very small number of students sometimes resort…” Despite what you read on the Internet or in sensationalized news accounts (of what may admittedly be a tragic events like a suicide), the vast majority of the total number of U.S. college students are not engaging in these behaviors to to pay for college. That’s just a fact.

    Second, you keep referring to “kids” and “students” and their ignorance or lack of care about tax deductions. I wasn’t talking about students–and certainly not 18-22 year old “kids” in my commentary. The fact, which you yourself raise, that average student loan debt per borrower is so large and takes decades to pay off attests to my point. I’m talking about people in their thirties, forties, fifties, and even sixties who have a vastly different perspective on taxes than a college junior with an unpaid summer internship at Boeing.

    I thank you for your comment. And I appreciate your passion. I just think the main thrust of your position–”kids” just don’t know or don’t understand–misapprehends the demographic I was writing about.

    Regards,
    Kloz

  • avatar Drew Martin says:

    I see this becoming a lot bigger than what it is now. I don’t understand why our public education doesn’t teach our future minds on how to balance a check book, make and maintain a budget, review loan documents, and learn basic knowledge of finances. We give them knowledge of math, English, science, wood shop, metal working, auto shop, and the arts, but none of those will prepare them for what is coming. I don’t see any changes on this or any other problems with finances until our young minds are taught.

  • avatar Brian says:

    Kloz – of course you’re absolutely correct.. The majority of students do not resort to those illegal acts I mentioned, or suicide for that matter.

    But thousands of kids do. It’s a buried dirty secret, but it happens all over the country.. Thousands of young women are signed up at “Sugar Daddy” websites and sleeping with dirty old men to pay for their schooling. Doesn’t sound like something you’d want your own 18-22 year old daughter doing I am sure, but it happens. It is a fact that women numbering into the thousands are doing exactly that, and they are “certified college students” once they use their .edu email address to sign up at those sites.. Young men are doing it too, but at a lower rate.

    The otherwise less “sensationalized” effect of being burdened (and burried) by debt is also real. Millions of students, young and old, are significantly impacted by the trauma caused by overwhelmed student loan and credit card debt. I’m talking about failed marriages, alcoholism, drug abuse, feelings of uncertainty for the future and helplessness.. Those effects are real and much more widespread.

    Although not caused singularly by being “in debt”, there’s a lot more going on here than just owing a few grand on student loans.. I’m basing these statements on 25 years in the business and at least that many as a consumer/student and pupil of the system we’re talking about.

    * I am not arguing with you, cause you’re right.

    The reason I’m referring to the borrowers as “kids” is because they are kids when they make these commitments. The very fact and idea that these financial commitments stretch far into adulthood makes my point of exactly how horrendous this whole situation is.

    If you were told, at 18 years old, that your choice of borrowing your way through 4-6 years of schooling would indebt you well into your late 30s, 40s or even 50s/60s, would you perhaps have tried to figure out another way?

    There are many options for our future college students, they’re just not made aware of them..

    I appreciate your article and shedding light on a not-so-sexy topic in our world of “AR management”..

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