If you’ve been following the latest figures on the rising student loan debt, you know the situation looks grim. As of 2019 Q2, Americans owe $1.61 trillion in student loan debt. Believe it or not, $1.61 trillion is an understatement.
It does not include the money parents and students borrow from their:
- credit cards,
- home equity lines of credit, or
- their retirement funds.
According to Sallie Mae’s annual survey on 800 parents and 800 students, about 5% of college costs are financed by other forms of debt. This includes home equity lines of credit (1%), credit cards (1%), and other loans (3%). Withdrawals from retirement savings cover an additional 1% of college costs. Read below to understand the secret of the steadily rising student loan debt.
The Dirty Secret of the Rising Student Loan Debt
Student loans are the fastest-growing source of debt for U.S. households. Since 2007 it has grown three times faster than auto loans and 150 times more than mortgages.
All this doom and gloom is old news. You should try to focus on another angle that hasn’t received as much coverage. And it’s not all bad news. It has to do with the growth in students who have opted for income-driven repayment (or IDR) programs. Keep reading to find out more about how it relates to the rising student loan debt.
IDR Programs and the Rising Student Loan Debt
As you probably know, income-driven repayment programs are designed to help people who are struggling to repay their student loans. If you make 150% of the poverty level for your family size in your state you can probably qualify. Instead of having to pay the monthly payment (interest and capital repayment) this program reduces monthly payments to 10% of your disposable income.
That is good news.
The bad news is the federal government does not “forgive” the interest you owe. It just adds it to your balance. So, debt balances often increase despite borrowers making regular payments.
However, there is another twist to IDR programs…
If you don’t miss a payment, the debt is (supposedly) forgiven after 20 years. Yes, whatever is still owed is discharged after 20 years. Regardless of how much you owe at the end of that period. This is the equivalent of a debt settlement. In many cases, a larger and generous settlement.
Is this arrangement going to become the new normal in student debt?
It certainly looks like it, if you look at the current trend in student debt by the repayment program. As you can see in the graph below, the amount of money in IDR programs now dwarfs other repayment programs.
Direct Student Loans by Repayment Program
Source: Department of Education
Federal Loans (Not IDR Programs) are Fueling the Rising Student Loan Debt
The percentage of students and student debt dollars in income-driven repayment programs is only increasing. As you can see in the graph below, the percentage of borrowers enrolled in an IDR program has more than doubled in 4 years. Nearly half (49%) of student debt was in IDR programs, as of 2018.
If these borrowers continue making payments until their 20-year period ends, taxpayers will be left holding the bill. Whether this is a good or bad thing will depend a lot on your political views.
However, remember that these programs are only available for:
- People who are not benefiting financially from their education. If you’re making more than 150% of the poverty level, you don’t qualify.
- Federal student loans. If you have private student loans, you will need to make your own arrangements with your lender.
The thing is, 92% of student loans are federally funded. In fact, the Department of Education is one of the biggest banks in the country.
So, it is federal loans — which have relatively low interest and are easier to qualify for — not IDR programs — which are fueling the rise in student debt.
Why is That The Case?
It wasn’t always like this. Up until July 2010, the government paid billions of dollars to banks and nonprofit agencies to lend money to students. The Student Aid and Fiscal Responsibility Act of 2009 changed all that.
The new legislation included a switch to 100% direct lending. Overnight, the Department of Education became the largest student loan lender in the country. The Department of Education doesn’t directly service these loans. It still employs financial institutions to answer the phone, send balance statements, and collect debts, but it is the direct lender of more than 44 million borrowers. Yes, that is not a typo. More than 10 percent of Americans have a federal student loan.
This is eye-popping, but still not necessarily a bad thing…
The Rising Student Loan Debt – In Conclusion
The growth in student debt can be seen as good news. People are borrowing to build human capital, and now they have that capital to lead more productive lives. However, the dirty secret is that not everybody is benefiting from the growth in college attendance.
The steady rise of borrowers who are not seeing a financial benefit to their investment (they go seek out a degree because they think it will make them successful…but have no plans on how to actually achieve it) tells us this does not always go to plan.
Some borrowers cannot pay down the loans with the higher income they expected to earn down the road. And, taxpayers are footing most of the bill with what amounts to a huge student loan debt settlement. This is okay if you want to subsidize education, but it’s something not many consider when calculating the cost of education.
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.