Student rates

The student loan mess and reform proposals

Second of two parts:

The value of outstanding student loans has doubled over the past decade and now stands at $1.7 trillion, surpassing all other forms of debt except mortgages. Many borrowers are barred from buying a home, and some Americans are even having part of their Social Security benefits garnished to pay off college loans. Meanwhile, a sizable cohort who never finished school must pay the piper even though the music has stopped.

Last week, we traced the evolution of the funding regime for higher education in the United States and the explosion of indebtedness and tuition fees. Today, an overview of some potential reforms.

Testing resources against future income. A college degree is an investment in future lifetime cash flow that is likely greater than the potential income from a single high school diploma. Like any other investment, borrowers and lenders should consider the potential return on investment or return on investment of such a substantial obligation.

Several studies have ranked ROI by college major using readily available public information. A 2021 comprehensive study by the Equal Opportunity Research Foundation looked at 30,000 bachelor’s degree programs and estimated a lifetime median income premium of $306,000 above an average high school graduate assuming a 100% chance of graduation. Adjusted for average dropout rates, that number drops to $129,000. However, 25% of bachelor’s degrees actually had a negative return on investment, which means that students in these programs do not recover the cost of their college education over their lifetime. STEM degrees, including computer science and engineering, had the highest return on investment, while fine arts, music, psychology, and religious studies had the lowest average return (often negative).

The disparity is even starker in higher education, which accounts for almost half of all student loan debt. About 40% of all masters have a negative return on investment.

This is certainly not to minimize the value of an arts or liberal studies degree, but from a purely financial perspective, in the absence of scholarships, the student should carefully consider the cost in their choice. of school.

The current system is agnostic as to future earning potential, unlike virtually any other source of credit. A student’s future repayment capacity should be an important factor in the loan equation.

– Require proof of financial literacy. The outcry from so many adults who say they didn’t understand the terms of their loans points to a gap in American understanding of personal finance. Before signing a 5-figure bond, ascending students should be required to take a basic financial literacy test or take a remedial course offered by their institution. Many universities administer entrance exams to assess math or language skills and require remedial courses to fill gaps. Demonstrating a basic understanding of a person’s loan obligation should also be considered a minimum requirement. “I was confused” is not enough when the Visa bill arrives.

– In-game skin for colleges. Given the high default rate of student loans, the current program represents a significant transfer of wealth from taxpayers to universities. Despite recent for-profit college scandals, most institutions have not been held sufficiently accountable for the results of the loan programs to which they refer or advise new students. Schools should be required to share some of the burden of unpaid loans and advances to students who do not graduate. Assuming partial responsibility for poor results would encourage financial aid officers to recommend appropriate packages.

Another proposal worth considering is a risk pool in which premiums are paid by institutions based on a percentage of loan origination. This insurance fund would partially compensate taxpayers against future loan losses, much like the FDIC covers bank depositors or the PBGC insures pension plans.

– Phasing out private loan servicing companies. When the private loan guarantee program ended in 2010, a political compromise allowed former lenders to retain their role of servicing and collecting existing guaranteed loans and all newly issued government direct loans. By any reasonable standard, the result was a wreck.

Nothing in the student loan complex has been more problematic than the framework of private sector companies acting as Uncle Sam’s contractors in loan servicing. Billions of dollars in profits have accrued to shareholders, executives and universities at the expense of borrowers and taxpayers over the life of the program. The industry has been plagued by scandals and replete with complaints of mismanagement, sloppy record keeping, conflicts of interest and outright fraud resulting in more than $2 billion in judgments and legal settlements. Thousands of borrowers have effectively been denied the assistance to which they were entitled or have been directed to predatory refinance programs.

In 2021, the Education Secretary announced substantial reforms to the failing system, prompting two major fixers out of the game. Greater transparency, a new centralized database and portal for borrowers, and plans Better defined income-tested reimbursement schemes are promising developments. But one thing the government knows how to do is raise money (although it’s still much better at spending it), and managing loan accounts isn’t much different than administering security benefits. social. Eliminate the middleman.

The list is hardly exhaustive and the reform can seem overwhelming. But inaction is hardly a viable option. Even after President Biden’s one-time relief, the total debt burden is expected to rebound to current levels over a decade. Debt forgiveness only treats the immediate symptom, but without systemic therapy for the underlying disease, the patient will relapse at taxpayer expense.

Christopher A. Hopkins is a Chartered Financial Analyst and co-founder of Apogee Wealth Advisors