Fixing Student Loans for Real
By accelerating the forgiveness of some income-tested student loans, President Biden performed minor cosmetic surgery on an abysmal system. Fortunately, there is a simple solution: let students and parents borrow and refinance their loans at the prevailing 30-year Treasury bond rate.
By accelerating the forgiveness of some income-tested student loans, President Biden performed cosmetic surgery on our atrocious federal student debt program. His actions will bring modicum of relief to less than a tenth of the 43 million Americans (one in six adults) who are in a collective shank of $1.75 trillion.
What’s wrong with federal student loans? For starters, two out of five college graduates never graduate. Half of the million annual dropouts leave college in debt. But when colleges “give” student loans to their admissions, none reveals that investing in college is one of life’s riskiest financial transactions.
How many of us would invest tens to hundreds of thousands of dollars in a business with a 40% chance of earning nothing? And who among us would double our risk by borrowing to make the investment?
College students can borrow up to $31,000 while trying to earn a degree. That’s less than median one-year earnings for college graduates. Still, $31,000 is well below the total college career costs of $200,000 at many schools. To “help” students cover the difference, Uncle Sam provides Parent-Plus Loans to parents of students. These loans, which grow rapidly, can land in the student’s lap. Or the student may end up paying it back indirectly by providing financial assistance to their retired parents. What if your parents don’t borrow on your behalf? You can take on more debt through private loans, all because of your complete lack of financial experience.
If Sam’s loan rates were moderate, student loans would be less of a concern. They are not. On July 1, Uncle Sam set his student loan rate at 3.73%, his graduate rate at 5.23% and his parental loan rate at 6.28%. These rates are much higher than the 10-year Treasury bond rate of 1.48% then prevailing – the rate Sam was able to borrow last July. As for private student loan rates? They can reach 13%!
Why is the federal government borrowing from X and lending at more than two to four times X? Because many borrowers cannot repay. In fact, two out of three adults with student loans currently owe more than they originally borrowed. In 2019, 12% of student loans were in default. Another 14 percent were postponed or abstained. In other words, at least one in five of the 45 million Americans in debt have not been able to repay what they owe. Thus, student borrowers have a 20% chance of not being able to repay or repay in full even in normal times. It’s no wonder that nearly 3 million Americans over the age of 60 are still responsible for educational costs incurred decades ago.
Once Uncle Sam has you in his usurious clutches, you’re stuck, potentially for life. Defaulting on student loans is nearly impossible. Your loans cannot, except on rare occasions, be subject to judicial liquidation. And if you don’t pay back, you’ll probably end up in a modern debtors’ prison. This includes transferring your loans to a collection agency, which can add 18% to the balance. First have your wages and later your Social Security benefits garnished. Lose your federal and state income tax refunds. Have an impaired credit history of up to seven years after having fully repaid. And being unable to borrow for a car or a house or even get a credit card.
Disabled with student debt? Pay or we’ll take part of your meager monthly disability check. According to recent statistics, more than 75,000 people with disabilities in the United States have their benefits garnished each month to pay off their student loans. Yet the amount seized is rarely sufficient to prevent the growth of what is owed. So you can be 99 and still repay your student loans.
If federal student loans could be refinanced, things would be different. They can not. They can be restructured – extended and in some cases made income dependent, but the rate is locked in for the life of the loan. You can also borrow at a variable rate rather than a fixed rate, but you cannot switch between the two. Suppose you took out some of your college loans in 2008 at the fixed rate of 6.8% then in effect. In this case, you’ve been paying 6.8% for 13 years now, even though interest rates over that time (until very recently) have dropped by about half!
Some in Congress have advocated more forgiveness. Senator Sanders, for example, calls for complete cancellation of student debt. But forgiving all student loans is unfair to those who repaid their loans or worked low wages in the public sector to get forgiveness.
Fortunately, there is a very simple and completely fair solution. Let students and parents borrow and refinance their loans at the prevailing 30-year Treasury bond rate. This rate is currently 2.94%, which is well below the rates of 4.50% for new colleges and 7.0 for graduate and Parent Plus student loans that will likely be set on July 1. This policy – Lending at Borrowing Rate – coupled with the ability to repay student loans in the event of bankruptcy will end the student loan crisis.
As for its cost, this plan will allow more people to repay and could well allow the system to be self-financing. If not, Uncle Sam will surely make up the difference by increasing future tax revenue. After all, the main driver of average taxes is worker productivity, which largely depends on the quality and quantity of education. Lending at the borrowing rate is certainly a policy that both parties can adopt. Like the bipartisan infrastructure bill, it invests in capital, but in the capital that matters most: human capital.