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STUDENT LOAN TRENDS

The last article focused on step two of the college funding process. It reviewed the types of student loans and broke them down into federal and private loans, as well as the subcategories of student and parent loans. Today, we continue by discussing student loans and the student loan crisis. Will there be a crisis or is it already here? What trends are taking place with student loans?

Funding College with Student Loans

Seven out of ten families will use some form of student loans to help pay for college. Many families accept this statistic as a normal part of sending a student to school. Some families see the current debt load of $1.4 trillion and focus on creating a lower or no-debt funding plan. The goal for later families is to help control early expense risk (increasing needed cash flow to duties that do not normally exist). With few or no student loans, young workers can save for retirement, a house, a baby, or other goals.

Problems do exist for students who have student loans and no degree. A worker with a college degree earns more over a lifetime than does a person without one. Imagine how much further behind a college drop will be when student loan payments enter the equation. Not only will this person earn less, but his or her expenses will increase.

Government Limiting Risk

As strange as it sounds, we can thank the government in some way for helping limit the expense risk that students face – specifically, those students who did not earn degrees. You may recall from the post Different Types of Student Loans that the federal government limits how much a student can borrow based on his or her year. Freshmen can borrow $5500, sophomores can borrow $6500, and juniors and seniors can borrow $7500. The caps limit risk by not letting underclassmen take out too much in federal student loans.

These limits make sense when one considers the high number of students who drop out of school. In risk management, this would be an example of risk reduction. The student’s risk of default does not go away but rather is limited to the lower amount of the Stafford loan. In terms of other types of student loans, this trend moves in the opposite direction. A quick review of the data below shows the point.

Notice the 25% growth in Parent PLUS loans and the almost doubling of the nonfederal loans? These are the loans that start getting families in trouble, which begs the question: How does this happen after more than a decade? After sitting by some of the families and helping them fill out their FAFSA forms this fall, I have no doubt that the process of going to college creates large amounts of stress for the student and the parent. Many feel that completing the FAFSA is not only harder but more stressful than completing their tax return.

When families receive their acceptance letters and aid packages, the sense of relief overcomes them and they pay little attention to the financial aid package. As consumers, we must keep in mind that these non-friendly loans become collateralized with Mom and Dad’s names or assets. Bankruptcy does not necessarily dismiss the debt, either.

Here we sit, in $1.4 trillion of student loan debt.

Student Loan Crisis

When do you call something a crisis? Is it after we push the ball off the cliff, or just before the tipping point of going over the cliff? Experts disagree on the answer, and some contend that a crisis does not exist. However, we cannot dispute the data. The following graph shows a different story (1.)

Nearly one-third of the federal education loan portfolio is in deferment, forbearance, or default. Not all delayed payments under these programs are negative. A student may qualify for a deferment for several reasons, like active duty, military service related to a war, a military operation, a national emergency, or enrollment in an approved rehabilitation training program for the disabled (2.). Other scenarios may qualify a person for deferment.

Simply looking at the default rate should make us uncomfortable. Mortgage delinquencies during the great recession topped out at 10.53% (3.). We are sitting at nearly the same rate on student loans. The public keeps sloughing off the concern. Major ramifications will likely result if the default rate continues increasing, which may drag on for some time. As mentioned before, student loans typically cannot be written off in a bankruptcy. Banks wrote off the bad mortgages from the Great Recession. For capital markets to work efficiently, this write-off process should be short. The markets then quickly adjusted to reprice the mortgage. The default of a student loan has the potential to go on for years or maybe decades as long as the borrower remains alive. Markets cannot be efficient with the current state of affairs, and inevitably delays the likely result of not recovering the principal amount of the loan.

Possible Crisis Scenarios

You know from my other posts that student loans have a negative effect on the individual. For example, when families have student loans, they save less for retirement and delay having children. Blow this effect up nationally and imagine how things change. The question to answer is: How do student loans with extended defaults affect spending and economic patterns?

What if it was easier to declare bankruptcy on student loans?

Perhaps the financial markets would be able to absorb the disruption more quickly than forcing a delay and extended process for dismissing the debt. Of course, the normal and negative side effects would accompany the dismissal. The family/individual would be able to move forward more quickly. Today, the issue is politicized, with no progress made in terms of reform or in the ability to dismiss the debt. The courts still use a standard – called the Brunner test – established in 1987 (4.).

Even debt holders using income-based-repayment plans face some economic challenges. By dragging out payments over 20 or 25 years, the worker pays more interest, which is not going toward other desired outcomes that contribute to current or future economic output. To put it another way, more dollars are spent on the past than on the present or future.

The current system has produced no significant changes. As mentioned before, debt has increased at a ridiculous rate. A rising interest rate environment creates a squeamish outlook for students who take out future loans and for those who hold variable rate loans.

Perhaps a different form of “forgiveness” should be reviewed, or we should let the markets help decide the fate of delinquent loans.

Next Step:

If your student is college bound, take the first step and create a college funding budget. Consider it the rudder on a ship; it will provide direction and prevent your student from facing the student loan crisis problems that this post has outlined. Second, create a smart lending strategy. This means knowing the rough starting salary of your career. The student should not graduate with more in debt than his or her first year’s salary. Shop for a school that meets the needs of your student socially, academically, and financially.

For those in school, take the time now to estimate the debt you will have accumulated upon graduation. Will you be eating ramen noodles or living the way you expect? If the former, make changes now to limit the damage. Take on a shift at a local business or at school. Do not borrow money for spring break trips. Take more credit hours or go to summer school so that you do not extend your academic career by another year or two.

Before your student heads off to college, make sure you know how much you can afford by using the free College Funding Snapshot Report.

Have questions? Call me at 317-805-0840 or email me at ncarmany@thewatermarkgrp.com.

Sources:

  1. Trends in Higher Education Series. PowerPoint. 30, October 2017.
  2. https://studentaid.ed.gov/sa/repay-loans/deferment-forbearance#deferment-eligibility
  3. https://fred.stlouisfed.org/series/DRSFRMACBS

http://www.studentloanborrowerassistance.org/bankruptcy/

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