No Need to Default, Ever.

We have often argued in the past that the best offense is a good defense. Students should avoid over borrowing in order to avoid the possibility of having excessive debt obligations. But obviously many students find out that the premises upon which they made their decisions were faulty. Whenever that unfortunate circumstance occurs a few students seem to opt for the most painful option available to them; default. That is a big mistake. Default is very costly; its implications stay with you for practically a life time and it is not warranted. There are many other options available to crack that nut. The following is a recent article that appeared in Businessweek that makes this very same argument:

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The Needless Tragedy of Student Loan Defaults

By Peter Coy on November 28, 2012

http://www.businessweek.com/articles/2012-11-28/the-needless-tragedy-of-student-loan-defaults

For the first time on record, the delinquency rate on student loans has jumped above the rate for credit cards, car loans, or any other kind of consumer loan. The tragedy? Many of those loans will default, with stunningly harsh consequences, even though there are many good options for debt relief—deferment, forebearance, or reductions in monthly payments.

“There is actually no rational reason for a borrower to be delinquent or default on their loans,” says Mark Kantrowitz, president of MK Consulting in Cranberry Township, Pa., and operator of the FinAid.org website.

Borrowers who are unemployed, in the military, or back in school can ask for up to three years or full or partial deferment on repayment of a federal loan. For those who have a job but don’t earn enough to cover the monthly payment, there are six options: graduated repayment, extended repayment, income-based repayment, income-contingent repayment, income-sensitive repayment, and pay-as-you-earn repayment. In other words, the federal government will do just about anything to keep borrowers from giving up and walking away completely.

If that’s the carrot, here’s the stick: Defaulting is “like a trip through hell with no light at the end of tunnel,” says Kantrowitz. The federal government can garnish up to 15 percent of a borrower’s wages, Social Security disability, and Social Security retirement income without a court order. Unlike other debt, student loans can’t be discharged in bankruptcy. Collection charges of up to 20 percent can be skimmed off the top of payments—enough to turn a 10-year loan into a 19-year loan. To say nothing of the lasting damage to a borrower’s credit score, which will make it hard or impossible to get a credit card, auto loan, or mortgage.

And, oh, by the way, if you win the lottery, the first winner from your windfall is the Education Department.

With that kind of downside, why do so many people default on their student loans? Some may not understand their options, or put off dealing with the problem. Also, research shows that many borrowers consider their student loans illegitimate and don’t feel they should have to pay them back. In fact, default rates are four times as high for dropouts, who presumably feel they didn’t get their money’s worth.

There’s a cyclical factor, too. The Federal Reserve Bank of New York reported on Nov. 27 that the percentage of student loan balances that were 90 or more days delinquent rose to 11 percent in the July-September quarter, higher than the delinquency rate on credit cards since the survey began in 2003. The spike comes at a time when youth unemployment remains historically high. Even for those with jobs, people are paying ever more money for educations that don’t equip them for jobs that pay them enough to cover their debts, as I wrote earlier this year in “Debt for Life.”

At the same time, delinquency rates on credit cards, auto loans, and mortgages have been falling because bad credit has been washed out of the system. There’s no such cleansing mechanism for student debt, which now totals $956 billion in outstanding loans, according to the New York Fed. The federal Consumer Financial Protection Bureau, using different methodologies, says student loan debt passed the $1 trillion mark sometime last winter.

Then there’s the fact that some of these student borrowers were probably lousy bets for repayment in the first place. The federal government, which holds 85 percent of outstanding student debt, doesn’t make loans to students based on their ability to repay them. That may sound crazy, but it is designed to ensure that students of all backgrounds and income levels get a shot at a college degree.

That willful blindness also sets up the government for huge losses. The purpose of the draconian punishment for defaulters is to make up for the lack of sound underwriting on the original lending. Clearly, though, the threats aren’t working—and neither are the multiple repayment options the government offers.

Are Universities Active Participants In The Student Loan Debacle?

The most recent report about student loans in the US is alarming. It reinforces what we already know that student loan debt in the nation has already surpassed the $ 1 trillion. That sum is larger than all of credit card debt put together.  This by itself is a cause for concern not only because of the implications on the individual student loan debtors but also because of the macro implications of dealing with such a high level of debt.  Whenever a nation is faced with the fact that tens of millions of its households will have difficulty meeting their financial obligations then one of the most important issues becomes that of the financial ramifications of this debt burden. Student loans are typically held by individuals in their twenties and increasingly in their thirties. If these individuals are to spend the next 10-25 years of their life paying back the loans that they had borrowed for their education then when are they going to save for their own retirement, purchasing a home, saving for their children’s’ college expenses…

One of the most distressing facts of the most recent report is the fact that 1.4 million student loan borrowers are already over $100,000 in debt. Such figures are mindboggling especially if we recall that most general affordability models suggest that total student loans should never exceed the expected first year earnings after graduation. This extraordinarily important issue ; debt in excess of what the quantitative models suggest is affordable, is an indictment of the current system that seems to be interested only in recruiting college students, arranging for them loans but never explaining in full and clear details what such obligations mean. The inevitable conclusion, based on the above, is to suggest that the financial institutions have no interest in reducing the flows of these loans since they are guaranteed by the federal government and that the same is equally true of many educational institutions that are either run for pure profits or that are not willing to inform the potential student loan recipients about the negative financial implications of such loans. As Eli Wiesel has often preached, those that acquiesce are just as guilty as those that pull the trigger. Unfortunately many of our universities have flunked the moral and ethical standards that one would have associated with such institutions of higher learning.

Note the dire implications of what the recent data reveals. 1.4 million students have student loan debt in excess of $100,000 when everyone knows that in general no loan above the expected first year earnings should be approved. How many degrees have an expected first year earnings of over $100,000? Not many. Besides those that are successful MD’s or the very few that are successful lawyers no one comes even close. But the country graduates only about 19,000 physicians every year and about 53000 lawyers pass the bar exam. But as hard as it might be to believe the country needs only 26,000 new lawyers each year. That is one reason that the median income for lawyers was only $44159 in 2009. As is obvious, there is only one conclusion: universities and colleges, including Pace University, have flunked the only test that counts, that of honesty and high ethical standards. No university has any business in either encouraging students to get in debt beyond what the models suggest is sustainable or not discouraging students from seeking such levels of indebtedness. Any other course of action is inexcusable and unconscionable.

Student Loans: Indentured Labour

Student loans in the United States have already surpassed the $1 Trillion mark. That is a huge sum of money that requires about $60 billion  in debt service every year. Such a level of indebtedness is equivalent to the sum of the official external debt of the Canadian government , $1.18 trillion, or that of Australia , $1.16 trillion. Actually there are only 13 countries in the world whose total sovereign debt exceeds $1 trllion and each of them has the power to tax.

We live in a world where education is the single most important factor in determining employment opportunities and consequently earning potential. That is a given. But what is equally true is that the above potential rewards make financial sense only up to a certain level of expenditure. When the student loan program was initiated the ROI was clearly attractive. Students borrowed relatively manageable sums of money to invest in a college education which in turn allowed the students to have an earnings stream that is sufficient to meet moderate living expenses, pay back their accumulated debt and yet set aside some savings for the future. This is no longer the case. Students often graduate with a debt load $100,000  and have to work at a job that pays $32,000 per year. That sum is not sufficient to pay rent, food and taxes not to mention student loan obligation.

So how did we get here from there? As is often the case, the explanation is complex and different groups have different  interpretations. It is safe though, to present this is a classical case of a blowback, a case of unexpected outcomes. The government had every intention to help students meet the expenses of higher education short of making it free ( remember that free education is not compatible with a market economy); the financial institutions were happy to oblige since the federal guaranteed program offered a safe outlet for loans; the colleges and universities rejoiced because they did not have to watch their expenses since .in the presence of "free" money, the tuition and fees can always be increased and   ;excuse the expression; the gullible student who at the tender age of 18 is willing to put her name to the dotted line with the unrealistic expectation that the degree earned in 4 years will increase earnings so much that making the required payments is not something to worry about. Yes all parties are to blame, just like the financial mess created by sub-prime mortgages. This is almost a parallel development. Instead of making money available to individuals with no job and no possibility of ever paying back the loans once the music stopped we are in this case advancing 18 year old students; who cannot otherwise find financing to buy a second hand car; huge sums of money without explaining to them clearly the potential ramifications of such behaviour. We never took the time to tell them that "There ain't no such thing as a free lunch" ; TANSTAAFL.; and that they are ordering a lunch that they will never be able to afford.  Unfortunately the sub-prime mortgages is not the only relevant analogy. Sovereign debt and fiscally irresponsible spending by many governments all over the world is another example that is in essence very close to what student loan debt has wrought. Governments all over the world were told that they can have their cake and eat it too. They were encouraged to borrow as if there was no tomorrow and to use the funds for all sorts of unproductive services. They were told that they can borrow their way into prosperity no matter what they do with the borrowed funds. Unfortunately that is exactly what our students have been told. Borrow as much as it takes, go to college, have a splendid four years and do not worry about the cost. Guess what, reality has a way of disrupting irrational dreams. Subprime borrowers lost their homes, governments are shrinking their public sector and college students in the US have become the new Indentured labour.

This is a nightmare and it does not have to be this way. If we all work together we can and we must overcome this problem for the sake of all of us and not only the students. The first step must be to stop the denial and recognize the problem. Once we do that then we have to coordinate all our efforts to find a fair solution. Please share with us your experience and let us know whether you think that such a blog can be helpful, if for nothing else but sharing information and giving you a voice.