Approaching $1 trillion, student loan debt has eclipsed credit card debt in America. Economic observers are finally paying attention, citing student loans as a looming bubble that could present another obstacle as the U.S. tries to recapture its economic footing. The cost of college continues to skyrocket, forcing students to borrow more, with borrowers from the class of 2010 averaging over $25,000 in student loan debt. Given the weak job market, it is no surprise that borrower default rates are climbing. Borrowers are financially crippled by their student loan debt and are unable to make any meaningful contribution to the economy. Congress has gone AWOL on the student loan debt issue, failing to realize the scale of the problem and ignoring the very real impact that the student loan debt burden has on the overall economy. While student loan debt has been a blip on the White House radar, the administration's efforts fall woefully short of making a real difference for borrowers, especially those who borrowed prior to 2012.
Student loan borrowers do not have a lobby. We do not have the money to fund congressional campaigns. There is no super PAC to fight for us. This fight is ours and ours alone. It is more critical than ever that we make our voices heard, especially to members of Congress. We need action now. There are simple and cost effective ways to fix America's broken student loan system. Below are six steps our government should immediately take to reduce student loan debt. Share this website and the petition with your friends and, more importantly, your congressional representative.
This measure could go the furthest towards reducing student loan debt. Federal student loan interest rates are unjustifiably high. Consider that the federal discount rate, the rate banks pay to borrow from the government, now sits at about 0.75% and has not been above 3.25% since March 2008. How much does the U.S. government pay to borrow money? The current 52-week Treasury Bill pays 0.17%, and the 10-year Treasury Note pays about 2.03%. Even mortgage rates have fallen below 4%. Federal student loans for graduate school are 6.8%. If Congress fails to act, undergraduate federal student loan interest rates will double to 6.8% in July 2012. Compared to other interest rates, federal student loan rates appear usurious. Why should student loan borrowers be the only sector of borrowers paying high interest rates? Moreover, consider that industrialized nations in Europe, Asia, and Australia offer student loan borrowers significantly lower interest rates for the life of the loans.
The obvious unfairness of the high interest rates American student loan borrowers pay is even more striking when considering that the federal Direct Loan Consolidation program never allowed borrowers to reconsolidate their loans to take advantage of lower interest rates. So, unlike refinancing a car, home, or any other purchase, many borrowers are stuck with the high rates that prevailed at the time of their consolidation. Borrowers who consolidated their student loans in 1999, for example, are paying interest at or near the maximum allowed rate of 8.25%. In the years since, subsequent borrowers were able to consolidate at rates near 2%. Congress has never acknowledged or addressed this disparity, thereby ensuring that hundreds of thousands—if not millions—of borrowers will continue to pay excessively and unnecessarily high interest rates. This translates into higher loan balances that, with interest compounding daily, take longer to pay down.
The solution: Set the interest rate on federal loans at 2.0%. Give all borrowers a one-year window to reconsolidate their loans at this rate. Administrative costs for a reconsolidation program could be offset by charging a fee for the reconsolidation. Such a fee should not be more than 1% of the outstanding loan balance for an individual borrower or $300, whichever figure is smaller. How much would this lower interest rate help? Repayment at 2% on a $25,000 federal student loan would save borrowers about $700 a year and $7,000 over the 10-year standard repayment period!
Acknowledging that borrowers were struggling with hefty monthly student loan payments, Congress passed legislation in 2007 allowing Income Based Repayment (IBR) and Income Contingent Repayment (ICR) Plans for federal student loans. Both the IBR and the ICR Plans rely on somewhat complex formulas that determine how much a person should pay on their student loans each month in relation to their income. In 2010, new legislation reduced IBR monthly payments from 15% to 10% of a borrower's discretionary income, beginning in July 2014. In 2011, President Obama announced that the start date for this reform would be moved up to 2012. Yet, the formula used to determine eligibility has made IBR out of reach for borrowers with anything approaching a moderate income. Indeed, only about 450,000 borrowers participate in IBR now, and President Obama's plan claims it will boost that number to about 1.6 million. But, there are at least 37 million borrowers now in repayment!
The ICR Plan for Direct Loans requires payments the lesser of
1) the amount the borrower would repay annually over 12 years using standard amortization multiplied by an income percentage factor that corresponds to the borrowers adjusted gross income as shown in the income percentage factor table in a notice published by the Secretary in the Federal Register or 2) 20% of discretionary income. Don't feel bad, no one in Congress knows how this works either.
The problem with the IBR and ICR Plans, and even the otherwise well-meaning legislation of the Student Loan Forgiveness Act of 2012 (H.R. 4170), is how the government defines discretionary income. In calculating repayment amounts, these plans define monthly discretionary income as (adjusted gross income) − (1.5 × the poverty level for the borrower's state of residence and family size) ÷ (12). This is simply not a realistic measure of an individual's actual discretionary income. It fails to account for the true costs of life's necessities.
The solution: The government must change how it defines and calculates discretionary income. Traditional economic definitions of discretionary income are considerably and justifiably more inclusive: discretionary income = (income) − (taxes) − (necessities), where necessities include expenses for food, rent or mortgage, utilities, healthcare, transportation, and other basic needs. The government should employ a similar formula for calculating actual discretionary income. Also, given the significant number of student loan borrowers who have private student loans in addition to their federal student loans, borrowers' private student loan payments should be considered as necessities when determining discretionary income levels. Monthly payments for all federal student loans should be capped at 10% of this newly defined discretionary income. Finally, any remaining debt after 15 years (180 payments) should be forgiven.
Many borrowers, especially those who have been in the workforce for some time, have retirement accounts such as IRAs, 401(k)s, or, if federal employees, through the Federal Thrift Savings Plan (FTSP). However, withdrawals from these accounts are either severely restricted as is the case with the FTSP, or simply do not make financial sense because of both the tax implications and the 10% penalty that is typically charged for early withdrawals. Among those student loan borrowers fortunate enough to be employed, many have done what they could to set aside some money for the future. Many of these borrowers would gladly use their retirement savings to pay off as much of their student loans as possible if this made financial sense. It does not make financial sense because of the taxes and penalties. Interestingly, one exception to the withdrawal penalty—at least for withdrawals from IRAs—is for paying for educational expenses for yourself or a dependent. Why not treat repayment of student loans as an education expense?
The solution: Allow borrowers to make one-time tax- and penalty-free withdrawals from any of their retirement accounts to repay student loans. If borrowers were able to pay off their student loans, they immediately could begin to replenish their retirement savings, save money for a house, and otherwise participate in the economy. The only expense to financial institutions and the government is the cost of foregone interest on the amounts repaid. Whatever this cost, it would be exceeded vastly by the opportunities that the rapid deposit of capital in the form of repaid student loan amounts would afford financial institutions and the government. Moreover, the repayment of federal student loans will put more money directly into federal coffers, a fact that has to appeal to lawmakers grappling with ways to reduce the ever-climbing federal deficit.
Currently, borrowers are allowed to deduct on their yearly tax returns the lesser of $2,500 or the amount of student loan interest they actually paid. Also, the current income phase-out level for the student loan interest deduction is $75,000 in modified adjusted gross income for single filers and $150,000 for married couples who file jointly. Both the deduction amount and income phase-out levels are too low and do not reflect economic realities. For example, graduates from professional degree programs in areas such as medicine, engineering, law, and social work often accumulate six-figure student loan debt levels. In many cases, the salaries these professionals go on to receive phase them out of the student loan interest deduction. Yet, the high monthly payments required to repay their loans effectively negate the advantages of higher income levels. Indeed, monthly student loan payments for some graduates are equivalent to or exceed mortgage payments, only in this case there is no house and no deduction for the interest paid.
In addition, Section 529 plans, or Qualified Tuition Programs, allow parents to save money for their children's college educations. In most cases, investments in Section 529 plans are not subject to federal, state, or local taxes. However, the preferable tax treatment for such plans did not become effective until 2002, which was long after many borrowers who are still in repayment completed their higher education. From both an economic and fairness standpoint, it would make sense to offer some tax advantages to people who did not have available such tax-friendly investment vehicles and who had to borrow significant amounts for their education expenses.
The solution: Borrowers should be allowed to deduct fully all interest paid on student loans. The income phase-out levels should be increased to $150,000 for single filers and $250,000 for married joint filers. A congressional bill containing similar provisions stalled in committee in 2010. Again, it is critical to remember that whatever tax revenues are lost by such measures, those revenues ultimately will be recaptured as this money will go from borrowers' pockets back into the economy.
While Public Service Loan Forgiveness (PSLF) most likely cannot be wholly retroactive, borrowers in qualifying public service positions before the government's enactment of the PSLF program should receive one year of credit for every two years they have worked in public service. This is important because of the way the PSLF program was structured. Under current law, only payments made after October 1, 2007, may be counted towards the required 120 payments for PSLF. There are thousands of longtime public service employees who have dutifully made monthly federal student loan payments during their employment. However, they cannot receive any credit for payments made prior to October 2007.
The solution: One way to address this problem that particularly affects older borrowers would be to allow for partial service/monthly payment credits. For example, public service borrowers with ten years of public service who made monthly student loan payments would be considered and credited as having already worked five years and presumably have made 60 of the required 120 payments, thus leaving only five years before being eligible for loan forgiveness.
But, there is still another problem: the types of payments required to qualify for PSLF. The current PSLF program limits qualifying payments to those made under the Income Based Repayment Plan, the Income Contingent Repayment Plan, the Standard Repayment Plan (10-year repayment period), or any other Direct Loan repayment plan where the payments are at least equal to the Standard Repayment Plan. Because public service positions typically pay less than private sector positions, many public service employees cannot afford to pay the amounts required by the Standard (10-year) Repayment Plan and meet the rest of their monthly obligations. Those borrowers have to opt for the Extended Repayment options. While the IBR and ICR plans were meant to address the needs of such borrowers, they fail to do so (see discussion above) because they do not take full account of an individual's actual life expenses. Fix the IBR and ICR plans as described above and this problem is solved.
The proposals above have dealt primarily with federal student loans. That is because it is federal student loan programs over which Congress has oversight and the most power to affect. As college costs have grown at more than double the rate of inflation, federal student loan programs and institutional grant aid have failed to keep pace, meaning that more students have had to resort to private lenders to cover higher education costs. Indeed, borrowers now owe approximately $170 billion to private lenders. Before the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, student loans originating from private lenders were treated the same as other types of unsecured consumer debt such as credit cards and could be discharged in bankruptcy. The 2005 bankruptcy bill amounted to a giveaway to private lenders like Sallie Mae and Citibank. Recognizing that this was wrong and unnecessary, Congress members from both the House and Senate introduced bills in 2010 and 2011 to restore bankruptcy as an option for private student loans. Those bills never made it out of committee.
The solution: Restore bankruptcy protection for private student loans. While everyone agrees that bankruptcy should be a last option for borrowers, that option is often rendered meaningless if borrowers are unable to include private student loans as part of bankruptcy proceedings. Private lenders must bear their share of responsibility for their lending decisions—something they had to do before 2005.