by Dr. Mark H. Shapiro
"He that dies pays all debts.".... ....William Shakespeare.
Commentary of the Day - April 4, 2007: The Student Loan Trap.
The Irascible Professor has commented a number of times in the past about the rapidly rising cost of a college education in the United States, and about the problems that creates for upward mobility in our society. One issue we haven't discussed previously is the extent to which the increasing cost of a college education is saddling both students and their parents with debts that often become unmanageable.
Colleges and universities often claim that they are helping students to meet the rising costs of a college education by expanding financial aid for students. What they fail to mention is that these days a "financial aid" package -- even for the neediest of students -- includes a large loan component in addition to whatever scholarships and grants the college or university may be able to provide. For many years the maximum Pell grant was just over $4,000 per year. On July 1, 2007 this will increase to slightly over $4,300 per year. However, for most students even in public colleges and universities this amount is far less than the annual cost of college. The difference is made up from student loans. The poorest students can obtain Perkins Loans. These are government subsidized loans that carry a 5% interest rate, and are made directly by the college to the student from a very limited pool of funds.
By far the majority of money for student loans comes from two other programs, the Stafford Loan program and the Parent Loan Program for Undergraduate Students (PLUS). Some of the Stafford Loan money comes from directly from the government, but a large fraction is provided by private lenders. The interest rate on Stafford Loans is fixed at 6.8% and the rate for PLUS loans is fixed at 8.5%. Students who qualify based on need, may obtain "subsidized" Stafford Loans. The student with a subsidized Stafford Loan makes no payment until six months after graduation or six months after ceasing to be at least a half-time student. The federal government pays the interest in the interim. Students with unsubsidized Stafford loans must begin payments immediately.
While the interest rate for Stafford Loans is relatively attractive, that does not tell the whole story. The federal government collects both a 3% "origination" fee and a 1% "insurance" fee on these loans. These fees are used to cover loans that go into default. Thus, to a large extent, private lenders who originate student loans or who purchase them in the secondary market are protected against defaults by the government. But the the private lenders have another great advantage when they provide Stafford or PLUS loans; namely, these debts last forever. If a person who has outstanding student loans falls on hard times, he or she cannot use the bankruptcy laws to discharge the debt. The individual (and often his parents who may have cosigned for the loan) has very limited options available to them if they are unable to make their loan payments on time and if full. In some circumstances, if a person becomes completely disabled the loan may be forgiven. In some limited situations, a person in default on a student loan may obtain deferment or forbearance on their loan. But short of that, the loan simply goes into default and the interest, late fees, and interest on late fees just continues to build.
Private lenders who hold student loan paper have been very aggressive in their collection efforts; and, because the government aids them by garnishing the debtor's income tax refunds and Social Security benefits the lenders seldom get stiffed. Instead, the hapless debtor continues to pay for decades while the amount he or she owes may actually increase owing to the late fees and interest on the late fees.
Private lenders have found the stream of income generated by aggressively applying late fees coupled with vigorous collection efforts to be quite lucrative. In fact, it's not unusual for a person who has gone into default on student loans to end up paying more than twice the original debt before everything is settled. Horror stories abound of individuals whose lives essentially have been destroyed by the efforts of the student loan debt collectors.
At the same time that these private lenders are extracting the last dime from their less fortunate customers, they have developed cozy relationships with college financial aid offices. In a March 29, 2007 New York Times article Jonathan D. Glater reported that a number of well-known colleges and universities have agreements with private lenders to answer telephone queries to their financial aid offices. In many cases students are not told that they are talking to a representative of the private lender rather than a school financial aid staff person. College and university financial aid officials also often receive favors from private lenders who are on their "preferred lender" lists, and some colleges actually have received kickbacks from their preferred lenders from loans taken out by their students.
The situation had gotten so bad that New York's attorney general, Andrew M. Cuomo, had started investigations into student loan practices at numerous colleges. The Chronicle of Higher Education reported on April 3, 2007 that Cuomo had reached settlements with 36 of these institutions that would prevent administrators from "accepting gifts from lenders, serving on paid lender-advisory boards, and entering into revenue sharing contracts with private lenders." Six of the institutions that had entered into such revenue sharing agreements also agreed to refund the money that they received to the students who actually took out the loans.
One other drawback of the current student loan situation is that it often forces college graduates to forego lower-paid public service careers in favor of the highest paying private sector job that they can find in order to avoid defaulting on their student loans.
In the view of the Irascible Professor, the college financial aid system in badly broken and in need of major repair. It will be up to Congress to do this, but unfortunately in the past private student loan providers contributed huge sums to the reelection campaigns of key members of Congress. It remains to be seen if the new Democratic Congress will behave more responsibly when it comes to student financial aid than their Republican predecessors did.