Why Those Student Loans Aren't Getting Paid Off
Last month, the US Department of Education admitted that a much larger number of students are defaulting on student loans than previously reported. According to the Wall Street Journal:
[T]he Education Department released a memo saying that it had overstated student loan repayment rates at most colleges and trade schools and provided updated numbers.
When The Wall Street Journal analyzed the new numbers, the data revealed that the Department previously had inflated the repayment rates for 99.8% of all colleges and trade schools in the country. The new analysis shows that at more than 1,000 colleges and trade schools, or about a quarter of the total, at least half the students had defaulted or failed to pay down at least $1 on their debt within seven years. [Emphasis added.]
An earlier report released in April had stated that "More than 40% of Americans who borrowed from the government’s main student-loan program aren’t making payments or are behind."
44 million Americans have at least some student loan debt for a total of 1.26 trillion dollars. The overall delinquency rate for these loans is 11.1 percent.
If that seems like no big deal, just imagine if we were talking about similar numbers for home loans.
[Related: Ryan McMaken discusses student loans on The Financial Exchange on WRKO-Boston.]
In the days following the foreclosure crisis of 2008 and 2009, approximately 10 percent of home loans were 90-days delinquent. But today, in a period when employment and earnings are vastly better than what they were in 2010, the delinquency rate for student loans is more than 11 percent, and has been that way for four years. Imagine if we were told that, year after year, more than one in ten homeowners simply weren't making payments in the midst of an economic expansion. It would be deemed an unsustainable disaster. And yet, that's what we're seeing with student loans right now.1
Indeed, the comparison with home loans appears apt, and can offer us some insights into what's wrong with the student loan process.
Students Loans Should be Priced According to Major
As with student loans, home loans are subsidized in a variety of ways, and this tends to drive up the price of the product being subsidized. But, with home loans, the terms of the loan are still at least partially based on the likelihood that the borrower will be able to pay back the loan. A borrower with low income and a poor credit history is going to pay more in interest and fees.
But, this is not how it's done with student loans. If student loans took default risk into account the way home loans do, students seeking engineering degrees or — other degrees that typically lead to higher wages — would cost the borrower less than would loans made to philosophy and art history majors.1
We already know, for instance, that recent graduates with economics degrees tend to pay much less of their earnings toward their student loans than do philosophy majors.
This is illustrated in a helpful calculator produced by the Hamilton Project at the Brookings Institution in which students can calculate his or her likely debt burden based on program of study.
In the comparison below, we find that in the first year after graduation, an economics major (green) pays nine percent of income toward debt service. Meanwhile, the philosophy major (blue) pays 20 percent of income toward debt service. These totals decline over time as earnings increase, but at no point in the first decade after graduation does the economics major approach the same debt load as the philosophy major.
Now, if student loans were more guided by market principles, and less guided by government policy, a student loan for a philosophy major would require higher interest payments than the economics major. Simply put, lending money to a philosophy major is a riskier proposition than lending it to an economics major. The interest rate would reflect this.
Should We Just Give Students More Time?
But maybe we just need to give students more time to pay off those loans? After all, as the Brookings Institution metric showed, the monthly burden of loans goes down quickly over time as earnings increase.
The problem in this case is that allowing students to simply defer their loans out five or ten years until their earnings go up is much easier said than done. In real life, if a borrower wants to take longer to pay off a loan he or she is going to end up paying more back in interest payments. Wouldn't it be nice if all new homeowners received a ten year grace period before they had to start making payments? This is rarely done because we know what such a grace period would really mean. It would mean that borrowers would ultimately have to pay more in interest, and would likely have to make payment for a longer period as well.
Moreover, for younger student borrowers, other life goals and needs are going to end up taking precedence over paying off student loans as time goes on. As their earnings increase, younger borrowers will become more interested in purchasing a house, starting a business, and having children. Yes, it's true that earning will go up over time for many borrowers, but so will other expenses.
The picture isn't much better for older borrowers. The Boston Globe recently featured two Baby Boomers in their 60s who are still often repaying student loan debt from decades earlier:
But [Annette] Pelaez and [Jane] Patrick aren’t fresh-faced graduates or even millennials. Both 63 years old, they are among the fastest-growing segment of borrowers burdened by student loans: Americans over age 60.
“I thought I would have paid them off a long time ago,” said Pelaez, who would like to retire in the next few years from her elder care job but owes $37,000 dating to the 1990s, when she returned to school to get master’s and doctoral degrees
Clearly, giving borrowers "more time" isn't the cure-all some advocates suggest.
On top of this, we might add the fact that student loans tend to be given out in amounts in excess of what even the students themselves report they need. The New York Times recently reported that:
More than half of students did not bother to calculate their postgraduate loan repayments, according to a report by the Global Financial Literacy Excellence Center at George Washington University, using data from the Finra Investor Education Foundation’s 2015 National Financial Capability Study.
According to a new study by NerdWallet, a financial tool website, nearly half of undergraduate students say that they could have borrowed less and still have afforded their educations. “On average, they said they borrowed $11,597 more than they needed for undergraduate study,” the NerdWallet report said.
Student loan money is so easy to come by that the students aren't even bothering to see if their degree program has the potential of providing relative ease in repaying loans.
This isn't to say that the only purpose of formal education is to increase earning potential. People may pursue degrees for a variety of reasons, and education is, quite frankly, a consumption good for many people who simply like going to school or having a degree hung on their wall.
Are we to believe, for example, that the 63-year old Annette Pelaez pursued her graduate degrees because she couldn't make a living wage otherwise? Was she just scraping by for forty years with her bachelor degree until economic necessity forced her back into school to finally finish that PhD?
In a functioning private marketplace for student loans, how would a lender price a loan made to an aging graduate student in her sixties? Are earnings likely to go up for that student as she approaches age 70 in a few years? Will she work 50-hour weeks in her late sixties to ensure she pays off her PhD loan quickly? That's unlikely, and loans would be priced accordingly.
Unfortunately, that's unlikely to happen any time soon. Since a formal education at a pricey university is now considered to be a "right," nearly all students have access to subsidized, low-interest loans regardless of the likelihood that the degree program will actually assist the student in ever paying the money back.
If we're looking for reasons why delinquency rates on student loans are so high, we shouldn't have to look very hard.
- 1. a. b. In 2012, delinquencies peaked at 17 percent, but this is only part of the story. A large number of borrowers who are not making payments on their loans are nevertheless technically not in default due to forebearances and other exemptions. See: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr668.pdf