Student Debt and College Cost Reforms

 

 Introduction:   This post is a quick list of fiscally prudent policies that could alleviate problems associated with increased college cost and student debt.

The proposals presented here involve two approaches to the problem.  The first approach (proposals one and two) entail policies ideally designed to decrease student debt totals or at least control the growing use of debt.   The second approach entails policies (proposals two through seven) designed to assist overextended student borrowers.

All policies presented here are designed to be fiscally prudent and to balance benefits and costs of taxpayers with student borrowers.   The proposals for additional assistance to students are a fraction of the cost of proposals for free or debt-free attendance at public universities offered in the 2016 Presidential campaign.   The new proposals to assist overextended student borrowers are more effective and less burdensome to tax payers than current debt-relief policies.

I have also worked on ideas on how to lower college costs by improving on-time graduation rates and lower the number of people who fail to complete college.   These ideas will be presented in a separate memo.

People who are interested in learning more about this topic should go to my student debt book at Amazon and Kindle.

Print Version:

https://www.amazon.com/Innovative-Solutions-College-Debt-Problem/dp/1982999446

Kindle Version:

https://www.amazon.com/dp/B07D9VV8K7/ref=rdr_kindle_ext_tmb

Proposal One:  Increased Financial Assistance for First-Year Students:  The primary goal of this proposal is the elimination or substantial reduction in loans taken out by first-year students.  Each state would create and administer a tuition assistance fund.   Money in the fund would come from three sources – the federal government, the state government and private donors.  The rules governing disbursement of the additional assistance would be determined by each state.

Advantages:

First-year students generally do not have a credit history and do not have a post-secondary academic record.  Many first-year students who fail to finish their degree have low incomes and substantial difficulty repaying their loans.  As a result, targeting assistance towards first-year students is more progressive than additional assistance spread over all students.

Increased financial assistance to the highly vulnerable first-year student population will result in a larger reduction in default rates than increased assistance to the general population of students.

Debt reduction targeted towards first-year students is an effective way to reduce interest accrued on student debt.

States and schools would be allowed significant latitude in designing benefits for different populations of students; although, the reduction in first-year student loan default and delinquency rates would remain an important objective of the program.

This proposal is substantially less expensive than free-college or debt-free college discussed during the 2016 Presidential campaign.  The program is not an entitlement.  The cost of the program would not exceed allocated funds.

Proposal Two:  Allocate around $100 million to a pilot program that will fund internships at start-up tech incubators.

Advantages:   Many people are taking unpaid internships to gain workforce skills. This option either adds to debt or is unaffordable for low-income students.

This program provides funds to startups with relatively little cash who might not otherwise be able to hire talent.

Only actively enrolled students seeking a degree are eligible for these positions.   The program does not take away jobs from people who are currently in the workforce.

The size of the program and the number of firms and students served is determined by funds available.   First come first served.

Proposal Three:  Interest rate reductions for older student debt balances:   Set the interest rate on guaranteed student loans to 1.0 percent after 15 years of active payments including negatively amortized payments.

Advantages: Under current law some debt forgiveness can be obtained for people who enroll in the income contingent loan programs. The automatic interest rate reduction after 15 years is easier to administer and fairer than programs offering loan forgiveness.

The interest rate reduction occurs automatically 15 years after loan repayment begins.

Interest rate reduction could not be blocked by loan servicers who currently often block annual re-enrollment in income contingent loan programs.

Loan servicers frequently fail to properly administer debt relief claims under loan forgiveness programs.

Under this program, all borrowers with outstanding student debt after 15 years will receive a lower interest rate.

This program does not provide loan forgiveness.   People who take out a 10-year student loan and pay on time will pay less than people who take out a longer maturity loan that leads to the interest rate reduction.

Under income contingent loan programs some people can increase the amount they borrow without increasing their lifetime repayment amount.  By contrast, under this proposal even with the interest rate reduction starting at year 15 total loan payments are larger for people who borrow more.

Proposal Four:  Reduce the link between interest rates on government guaranteed student debt and market interest rates: 

 Rules would be changed to create an interest rate floor 4 percent and cap 6 percent regardless of the 10-year interest rate.

Note on current law:   Current law links the interest rate on student debt to the 10-year government bond rate.

Advantages:  High interest rates on student debt was a pressing problem in the 1980s and 1990s.   A return to high interest rates would be much worse today because education costs, the proportion of students taking out debt and the amount of student debt per borrower have all gone up.

Failure to alter the link between market interest rates and student loan rates could reduce access to education or increase costs for an entire cohort of students.

This is a potentially pressing problem now that the Federal Reserve has begun raising interest rates.

Proposal Five:  Change rules governing PLUS loans to parents:  Limit parent guarantor obligations on Parent Plus Loans and Private Student Debt to Five Years after initial payment.   The student borrower would be exclusively responsible for the loan at the end of the five-year period.

Advantages:    Currently parents on a PLUS loan are responsible for the loan until they die.   Many of the parents who cosign PLUS loans for their children have low income.  In 2012, an estimated 6.2 percent of parents of dependent undergraduate students with income in the bottom quartile had taken out a PLUS loan.   More alarming, in 2012 over 11 percent of graduate students with parent + student income in the bottom quartile had taken out a PLUS loans.

Many of the parents with PLUS loans are nearing retirement.   Limiting their responsibility would reduce the number of older Americans with unpaid student debt.

There appears to be some bipartisan support for changes in laws that would provide some debt relief to parents who sign PLUS loans.   Under current law, parents who take out PLUS loans can only have the loan discharged if they become disable or if their child dies.  Under current rules, parents with PLUS loans with children borrowers who become disabled and cannot have their loan discharged.  A bipartisan bill in Congress seeks to allow discharges of PLUS loans for parents of students who become disabled.

https://www.cnbc.com/2018/12/05/she-took-out-20000-in-loans-for-her-sons-college-then-he-went-blind-.html

Proposal Six:    Reconsider treatment of student debt in bankruptcy including rules governing priority in chapter 13 bankruptcy and discharging of private student loans in both chapter 7 and chapter 13.

 The general goal is to assure that student debtors who enter chapter 13 bankruptcy leave bankruptcy after seven years with a substantial reduction in the amount of student debt they owe.

Advantages:   Many student borrowers who currently enter chapter 13 bankruptcy will exit bankruptcy without substantially reducing their student debt obligations.

This change will increase student debt payments for people in chapter 13 bankruptcy by allowing for reductions in payments on credit card debt and other consumer loans.  Total payments in Chapter 13 bankruptcy would remain unchanged but taxpayers would receive more payment and other unsecured creditors less payment.

This change would reduce the number of occasions where a student borrower dies prior to repaying his or her entire student loan.   This represent a direct gain to taxpayers because student debt, like other consumer loans, is forgiven when the borrower dies.

The new rule could be applied to both publicly guaranteed debt and private student loans.   The 2005 bankruptcy law made it difficult to discharge student debt in bankruptcy.  A return to the pre-2005 bankruptcy rules by allowing for the discharge of private student loans would allow student borrowers to accelerate payments on government guaranteed student debt.   This change would also benefit taxpayers.

Proposal Seven: Revise Public Service Loan Programs: New program will provide up to $40,000 in loan forgiveness after four years in a public service job.  Current law provides more loan relief after ten year.

Note:

The budget offered by the Trump Administration proposes to eliminate the public service loan program starting in 2019.   It is not clear how this proposal or any which passes Congress will affect people who are currently applying for assistance through the public service loan program.

Advantages:

The new law by providing limiting loan relief to $40,000 allocates more relief to people with modest debts and modest incomes, rather than relatively high-income professionals.

The shorter period for debt relief allows people to move to a more productive opportunity and reduces job lock.

Concluding Remarks:  The progressive wing of the Democratic party want free college and debt forgiveness programs.   The Trump Administration is advocating weakened consumer protections, changes to income contingent loan programs, elimination of subsidized student loans and the elimination of the public service loan program.

This centrist approach, presented here, differs sharply from both the policies offered by the progressive wing of the Democratic party and by the Trump Administration.

 

 

 

The Politics of Student Debt

In a recent episode of Madam Secretary, the daughter of the Secretary quits her volunteer position on a Congressional campaign because her candidate did not have a bullet point on forgiving student debt.   The candidate explains to her that debt forgiveness is too controversial because it takes money from workers and taxpayers and give money to students.  The Secretary lectures the daughter and persuades her to vote despite her problems with this candidate on this one issue.

This episode relives one of the flash points of the 2016 Clinton/Sanders contest.   Bernie Sanders supported an expensive and unrealistic free college program. This idea was first scorned and then matched by Clinton.  Clinton continued to struggle with the issue by coming up with ideas like let’s forgive debt for employees at start-up firms an idea that was laughed at by virtually everyone who has studied the student debt problem.

Student debt is a growing problem much larger for the current cohort than for previous generations.

  • The percent of graduate with student debt went from 50 in 1989/1990 to near 70 today.
  • The percent of borrowers leaving school with more than $50,000 in debt went from 2 percent to 17 percent over same period.
  • The number of Americans over age 65 with student debt increased by a factor of 4 between 2005 and 2015.

High student debt levels have long term financial consequences.  People with high student debt levels often either delay savings for retirement or delay loan repayments.   Often student debtors also delay marriage, forego having children and choose to rent rather than purchase a home.

Trump Administration proposals will worsen student debt problems.  The Trump Administration is proposing to eliminate subsidized student loans, a change that will increase debt costs and cause many to forego college.  The Trump Administration has rejected loan forgiveness applications under the public service loan programs and their actions will weaken the Income Based Replacement loan program.   The Trump team does not support of enforce rules protecting students from fraud.

Student debt like health care should be a big wining issue for Democrats.  Unfortunately, Democrats are divided between keeping the status quo and giving free college to everyone.

Doing nothing should not be an option.  Part of the solution involves increased financial assistance to students, especially for first-year students.

Many students leave college after their first year because of academic performance.  Problems associated with first year students who fail to continue their education could be substantially reduced in a cost-effective way by expanding assistance to first-year students.

Part of the solution involves policies and programs which improve on-time and early graduation rates.

Many students either fail to graduate or take more than the allotted time to complete their program.  These students tend to take on more debt and are more likely to incur payment problems.

Realistically, improvements in and expansion of debt forgiveness programs must be part of the solution because many borrowers become hopelessly overextended.  Some Democrats are currently focused on expanding the Income Based Replacement loan program.   Loan servicers regularly ignore the IBR options and debt forgiveness programs centered on the IBR program are likely to fail.

There are other more cost-effective ways to assist overextended borrowers.

Granting priority to student debt over consumer loans in Chapter 13 bankruptcy:     Currently, many applicants for Chapter 13 bankruptcy reduce student loan payments to repay credit cards and other consumer loans.  Often the student borrower leaves bankruptcy with an increased student debt balance.  The quicker repayment of student loans in bankruptcy benefits both taxpayers and student debtors.

The elimination of the link between market interest rates and interest rates on federally guaranteed student loans.   Under current rules student debt interest rates are tied to market interest rates.   This policy automatically increases costs for an entire cohort should Treasury rates rise.  This is a timely problem given recent Fed statements and moves.

Modification of the standard contract on student loans to allow for interest-only payments rather than forbearances and to allow for reduction or even elimination of interest rates after 15 years of payments:   The IBR program allows some people to borrow more without increasing the amount they repay.  By contrast, under the proposed interest elimination plan, people who borrow more repay more.  This program has better incentives and is less expensive to the taxpayer than the IBR program.

Restricting parental guarantee obligations on PLUS loans and cosigned private student loans to 5 years from repayment date:   Many of the most severe financial problems associated with student debt involve PLUS loans guaranteed by parents.   This change would reduce these problems.

 Removal of the prohibition against the discharge of high-interest private student loans in bankruptcy: This proposal returns us to rules that existed prior to the enactment of the 2004 bankruptcy law.   The discharge of private student debt in bankruptcy could accelerate payment on government guaranteed debt and assist taxpayers.

Creation of a modified public service loan program, which will allow for partial loan forgiveness after 2 to 5 years rather than 10 years of public service:   The current program creates job lock by forcing applicants to wait at least 10 years for loan forgiveness.  The shorter period for partial loan relief for the new program reduces job lock.  This program will be less expensive and have lower administrative costs than the current program.

Issues like student debt and health insurance are core issues to Democratic voters, which should drive voters to the polls.  However, there are huge differences in the way the Sanders wing and the Clinton wing approach the problem.   The Sanders proposals would cause either a fiscal crisis or unsustainable tax increases combined with stagnation.   The Clinton wing is proposing a band aid for the sake of appearances.

I understand why the screen writers of the show on Madam Secretary are frustrated at the Sander’s supporters who chose to stay home in 2016 rather than vote for an imperfect candidate who is a thousand times better than Trump.   However, Democratic candidates must have a comprehensive vision and set of policies on student debt.   College costs and debt are an existential problem for current students and recent grads.   The cost of college will deter many from getting necessary education.   The debt incurred will have long term often crippling impacts on household finances and even happiness.

There are common sense centrist solutions to this problem that increase access to education, reduce costs for overextended students and are fair to workers and taxpayers.

The failure of the Democrats to address student debt issues is sort of like a football team deciding to punt on first down.  This is not an effective way to either win the game or excite your fan base.

 

Authors Note:

David Bernstein is the author of Innovative Solutions to the College Debt Problem.   Get his book on Amazon or on Kindle.

 

https://www.amazon.com/Innovative-Solutions-College-Debt-Problem/dp/1982999446

David has also written on health care and the ACA.

 

Go here for a Centrist Health Plan:

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3263159

 

 

I would love to work for a centrist Democrat in 2020.  Contact me at Bernstein.book1958@gmail.com or on my cell 202 413 5492.

 

 

How much house can a student borrower qualify for?

How much house can a student borrower qualify for?

This answer depends on the maturity of the student loan.

Situation:

Consider a person with a $100,000 student debt.

  • The person can either pay the debt back over a 10-year period or a 20-year period.
  • The student loan is this person’s only consumer debt.
  •  The person earns $80,000 per year.
  • The student loan interest rate is 7.0 percent.
  • The mortgage interest rate is 4.0 percent.
  • The mortgage term is 30 years.

Questions:

  • How much mortgage can the person qualify for if the person keeps the student loan at 10 years?
  • How much mortgage can the person qualify for if the person changes the student loan term to 20 years?
  • What is the increased cost of the student loan payments involved by switching from a 10-year to 20-year student loan?

Answer:   I developed a spreadsheet that calculates the maximum allowable mortgage this person can qualify for.

In order to qualify for a mortgage two conditions must hold.

  • Monthly mortgage payments must be less than 28% of income.
  • Monthly mortgage and consumer loan payments must be less than 38% of income.

The procedure used to calculate the allowable mortgage is as follows:

  • First, I calculate the maximum allowable mortgage payment based on zero consumer debt.   This value is 28 percent of monthly income.
  • Second, I calculate the maximum allowable mortgage payment consistent with mortgage payments and consumer debt payments equal to 38 percent of income.   This is done by backing out the student loan and allocating the rest to mortgage debt.
  • Third, I insert mortgage interest rate, term and payment info into the PV functions to get the mortgage amount
  • Fourth, The allowable mortgage is the minimum of the mortgage totals consistent with the two constraints.

The calculations for the two situations presented in this problem are presented in the table below

Mortgage Qualification Example for Borrower with Student Debt
row # Student Loan Information Note
1 Student loan Amount $100,000 $100,000 Assumption
2 Interest Rate 0.07 0.07 Assumption
3 Number of Payments 120 240 Assumption
4 Student Loan Payment $1,161 $775 From  PMT Function
Mortgage Information
5 Rate 0.035 0.035
6 Term 360 360
Income Assumption
7 Income $80,000 $80,000 Assumption
8 Constraint One:  Maximum monthly mortgage payment consistent with this income assumption $1,867 $1,867 28% of monthly income
9 Constraint Two:  Maximum monthly consumer and mortgage payments consistent with income $2,533 $2,533 38% of monthly income
10 Maximum mortgage consistent with constraint one. $415,697 $415,697 pv of mortgage rate number of periods, and pmt where mortgage rate and payments are assumptions baed on the market and product chosen and payment is max allowable given   income
11 Allowable mortgage payment consistent with constraint two given required student debt $1,372 $1,758 Row 9 minus Row 7
12 Max mortgage consistent with borrowing contraint two. $305,593 $391,505 Use PV function with rate and term set by market and product and payment the amount of mortgage payment after required consumer payments
13 Allowable mortgage debt $305,593 $391,505 Minimum of Row 10 and Row 12

 

An increase in the term of the student loan from 10 to 20 years increases the size of a mortgage a household can qualify for from $305,000 to $391,000.

Getting the extra mortgage is not cheap.  The increased student loan term causes total student loan payments to go from $139.000 to $186,000.

Concluding thoughts:  Most people who have $100,000 in student debt will have to refinance the student loan if they are going to buy a house.

 

 

 

 

 

 

 

 

 

 

Student debt and qualifying for a mortgage

Student debt and qualifying for a mortgage  — post one

Excel Topics:  PMT function and Spreadsheet design

Question:  A person graduates from college and graduate school with $100,000 in student debt.   The interest rate on a 10-year student loan is 5% per year.   The person wants to buy a house that costs $300,000 with a 90% LTV loan. The home mortgage interest rate is 4.5% on a 30 year FRM.

Assume that in order to qualify for the house the person must meet two conditions.

Constraint One:  The ratio of mortgage interest to income must be less than 0.28.

Constraint Two: The ratio of total interest (mortgage and non-mortgage) interest must be less than 0.38.

How much income does this person need to qualify for a loan on this house?

Why might student debt have a smaller impact on the purchase of a $700,000 home than the purchase of a $300,000 home.

Analysis:   The analysis for the $300,000 home is laid out in the table below.

Mortgage Qualification Example for Borrower with Student Debt
Note
Student loan Amount $100,000 $0 Assumption
Interest Rate 0.05 0.05 Assumption
Number of Payments 120 120 Assumption
Student Loan Payment $1,061 $0 From  PMT Function
House Amount $300,000 $300,000 Assumption
LTV 0.9 0.9 Assumption
Loan Amount $270,000 $270,000 LTV * House Amount
Intrerest Rate 0.045 0.045 Assumption
Number of Payments 360 360 Assumption
Mortgage Payment $1,368 $1,368 From PMT Function
Total Loan Payments $2,429 $1,368 Sum Payments
Monthly Income Constraint One $4,886 $4,886 Student Loan Payment divided by 0.28
Monthly Income Constraint Two $6,391 $3,600 Mortgate Payment Divided by 0.38
Required Monthly Income $6,391 $4,886 Max of income over both constraints
Required Annual Income $76,696 $58,631 12* Max Income

Observations Pertaining to the $300,000 home for a person with and without student loans

A person with no student debt could qualify for this mortgage with an annual income of $58,630.

The person with the student debt needs an annual income of $71,585.

The impact of student debt on purchases of a larger home:   The allowable mortgage is determined by two constraints one involving mortgage debt only and the other involving the sum of mortgage and consumer debt.   When the mortgage debt is very large, constraint one (the mortgage debt constraint) will be the binding constraint.

Download the student debt and mortgage qualification spreadsheet by clicking below:
Continue reading “Student debt and qualifying for a mortgage”

Increases in Undergraduate Debt 2003/2004 to 2011/2012

The statistics presented in this post document the dramatic increase in student debt between 2004 and 2012.

Increases in Undergraduate Debt 2003/2004 to 2011/2012

 

My holiday visit with in-laws included less discussion of politics this year for obvious reasons but I did have a brief discussion on student debt with one relative.   His view of the issue is that since his generation paid for their college no additional cost subsidies are needed. My concern is that the recent increases in costs are having substantial adverse impacts on the current cohort of students.

 

I am planning several more posts on college costs and their economic and impacts.   This post looks at the trend growth of student debt between the 2003/2004 and the 2011/2012 academic years.

 

The Data: The source of data for this study is the NSPAS database. I was able to access the data from the NCES Power Statistics Portal.

 

https://nces.ed.gov/datalab/index.aspx

 

My variable of interest in this post is cumulative amount borrowed in the undergraduate years by people receiving a bachelor’s degree at four-year institutions.   I have presented separate tables for private and public four-year institutions.
Three statistics are presented – Average debt for borrowers, the percent of students who borrowed, and the percent of students who borrowed more than $25,000.

 

The data does not include information on borrowing by parents through the PLUS program.

 

Statistical Results:

 

The statistics describing change in cumulative student debt are presented in the table below.

 

Cumulative Under Graduate Student Debt at Four-Year Institutions

2004 to 2012

Bachelors Degree Four-Year Public
2003/2004 2011/2012 Diff. % Diff.
Average Debt for Borrowers $11,958 $18,845 $6,887 57.6%
% of Students who Borrowed 56.6 63.5 6.9 12.1%
% of Students with debt greater than $25,000 5.3 16.9 11.6 218.7%
Bachelors Degree Four-Year Private
2003/2004 2011/2012 Difference % Diff
Average Debt for Borrowers 14,536 22,962 $8,426 58.0%
% of Students who Borrowed 66.9 69.1 2.2 3.3%
% of Students with debt greater than $25,000 9.6 22.9 13.3 138.0%
Both Public and Private Four-Year Programs
Average Debt for Borrowers 12,876 20,163 $7,287 56.6%
% of Students who Borrowed 60.8 65.2 4.4 7.2%
% of Students with debt greater than $25,000 6.8 18.7 11.9 176.4%

 

 

Summary of Statistical Results:

 

The growth of cumulative student debt among people receiving a bachelor’s degree from a four-year institution was tremendous during this brief eight-year period.

 

 

Total debt incurred by student borrowers receiving a bachelor’s degree rose by around 57% over this eight year period.

 

The proportion of undergraduate bachelor degree students incurring debt rose by 6.9 percentage points at public institutions and 2.2 percentage points at private institutions.

 

The proportion of undergraduate bachelor degree students incurring more than $25,000 in debt went from 5.3% to 16.9 percent for students at public schools and from 9.6 percent to 22.9 percent for students at private institutions.

 

Other Student Debt Trends

 

These issues will be addressed in future posts.

 

The expansion of PLUS loans to parents:

 

Increases in the use of private debt:

 

Changes in debt incurred by graduate students:

 

Changes in the number of students with excessive levels of student debt:

 

 

Economic Financial and Social Implications:

 

 

Economic issues related to the increase in student debt include – (1) A decision by many young people to live with parents and delays in starting a family, (2) a decision to delay home purchases, (3) the choice between a 30-year and 15-year mortgage, and (4) a decision to delay placing funds in a 401(k) plan.

 

Many older financial experts do not agree with the decision by many in the current generation to delay home purchases and delay saving for retirement.

 

My view is that the older generation is not in fully touch with the economic realities facing many in the millennial generation from the explosion in student debt occurring over a mere eight years.

 

I am planning a lot more empirical work on this issue.

 

PREVIOUS WORK:

 

Some of my previous work examines proposal to provide financial relief to some debtors who get over their head in debt. Here are some examples:

 

 

Seven Ways to Provide Debt Relief:

http://betterworldpolicies.blogspot.com/2016/09/seven-ways-to-provide-student-debt.html

 

Is IBR the best way to provide student loan debt relief:

http://betterworldpolicies.blogspot.com/2016/09/is-ibr-best-way-to-provide-student-loan_8.html

 

 

In addition, I have a short book on Kindle on managing debt and the impact of debt on lifetime savings.

 

The Nine Essays on Debt and Your Retirement:

http://amzn.to/2iYe1iV