When you think about America's student loan crisis, it helps to break the issue into two halves. First, you have the the sheer amount of debt students are piling on. This part of the problem is familiar. It tends to get exaggerated a bit, but in the end, there are millions of former students out there struggling under the weight of loans that, 15 or 20 years ago, they would not have needed to borrow in order to make it through college.
The second half of the crisis earns less attention, but is in some ways equally important. It's our broken system for helping students manage their debt. With all of the repayment plans available to borrowers, some of which cap monthly payments based on income, it should theoretically be damn near impossible to default on a federal student loan. And yet it happens constantly. Among former students who started paying back their loans in 2009, 13 percent had defaulted within 3 years. A disturbing number of students are falling through the cracks.
This week, the Consumer Financial Protection Bureau released a new report that illustrates just how severe that systemic failure really is (all tables below are courtesy of the CFPB). The big, headline grabbing number from it is that almost one third of all federal borrowers have either defaulted on their debt, or are in deferment or forbearance, meaning they're likely in such bad financial shape that they've been given a temporary break on paying back their loans.
Repayment Status Among Federal Student Loan Borrowers*
Those deferment and forbearance numbers are worrisome, but there's a faint silver lining to them. These borrowers might not be paying back their debts, but they've figured out how not to drown in them.
There's no silver lining, though, to the 12.8 percent overall default rate. Those are the people whom the system has failed completely. There's no strategic reason for a borrower to default on their student loans, since it's virtually impossible to discharge them in bankruptcy. It's just a sign that something has gone wrong.
And what's going wrong seems pretty clear: The students at risk of defaulting aren't taking advantage of the programs meant to help them.
As shown in the table below, fewer than a million students are currently enrolled in Income-Based Repayment (IBR) or its newer, even more generous cousin, Pay as You Earn. Both programs limit monthly payments based on earnings. They would help millions of additional borrowers ... if only those borrowers knew about or used them.
Repayment Plans Among Direct Loan Borrowers
(In Repayment, Deferment, or Forbearance)
It gets worse, though. The average loan balance for students using IBR is $55,900, which would land you in roughly the top 15 percent of all student debtors. The average student in default, as shown below, owes far less -- $14,500 if they borrowed directly from the government, and $13,400 if they borrowed under the old Federal Family Education Loan Program that was discontinued in 2010. In fact, the defaulters have the lowest balances of any group not in school or in a grace period.
Average Federal Loan Balance by Repayment Status
So big borrowers are surviving, and modest borrowers are struggling. What's going on?
As I've written before, and the New America Foundation's Alex Holt and Ben Miller observed earlier this week, many of the student borrowers running into trouble are almost certainly college dropouts who never got any sort of debt counseling, and automatically enrolled in a standard 10-year plan. That would explain their low overall debt totals -- fewer years in school mean fewer loans -- and why they're not finding a repayment program that will save them from default. (And remember, a whole 29 percent of borrowers appear to drop out of school).
Meanwhile, the high debt levels among borrowers in IBR suggest that many of them are probably former graduate students, who are generally better equipped to navigate the federal government's byzantine repayment system. As Holt and Miller explain:
We can't know from these numbers, alone, exactly who these borrowers are, but here are some educated guesses as to why graduate students might be more likely to use IBR. Students selecting IBR have to navigate a multitude of repayment options and then complete paperwork that is notoriously complicated and difficult to use. This creates an immediate disposition toward not making choices and just using the standard 10-year repayment plan, which the table above shows is the most popular option. While struggling dropouts would likely benefit from IBR, they've probably lost touch with their school and probably aren't getting much support in choosing the right repayment plan. Borrowers with advanced degrees and proactive financial aid offices, on the other hand, have a significant incentive to make sure higher debt balances don't become unmanageable. (There is evidence that graduate schools exert a significant amount of effort helping students enroll in IBR.)
We have a student debt system that leaves the most vulnerable, least sophisticated borrowers to fend for themselves. And we're seeing the unfortunate results in our default rates.
If we're going to continue handing federal loans to any student, regardless of credit history or family income, we need to rethink the way we ask them to repay those debts. A Republican congressman, Tom Petri, has introduced legislation that would automatically enroll all students in an income-based repayment program, in which monthly payments would be collected straight from their paychecks much the same way as payroll taxes. There are details of Petri's bill that many liberals will hate. It would cap payments at 15 percent of a borrower's disposable income, for instance, whereas the current Pay As You Earn program caps them at 10 percent. But with today's system so obviously and needlessly failing to protect millions of borrowers, it seems like Petri fundamentally has the right idea. It would do away with the confusing paperwork and onerous requirements that lead so many students into the wrong repayment plan. And it would end credit-wrecking defaults. It won't address the fundamental problem of students needing to borrow in the first place. But it would make that borrowing far less dangerous.
Student loans are the closest thing in the U.S. to a financial product marketed directly to children. It's time we put up better safety rails for the borrowers.
*This header has been corrected to clarify that the table only refers to federal student loans, not private loans. For those interested, the CFPB estimates that Americans are carrying $165 billion worth of private student loans and nearly $1.2 trillion worth of student debt total.