Clearly there is a great deal of misinformation out there about the Federal student-loan program. It has led some to erroneously conclude that student loans are the new subprime mortgages. While such suggestions make for sensational headlines for some, and generate book sales for others, in reality, there are relatively few similarities between the two types of loans. I am not saying that the Federal student loan program is without its share of problems, but student loans and subprime mortgages differ in a number of important ways.
I’ll admit that there are two ways in which subprime mortgages are similar to student loans. The first is that both were created in order to achieve some larger public-policy goal that received almost unanimous bipartisan support over the past several decades. In the case of subprime mortgages, this practice supported the goal of increasing home ownership while in the case of student loans the program allowed more people to earn a college credential. Whether or not it is true that all people should own a home or that all people should go to college is a question worthy of serious debate, but that was the goal and loan programs were the enabler.
The second similarity is that both programs allow the borrower to enjoy reduced or defered payments in the early years of repayment. In the case of student loans, there is a compelling reason behind Congress’s decision to allow students to defer all payments until after graduation, which is that students who work fewer hours while in school tend to be more likely to succeed and graduate.
With these couple of similarities revealed, it is time to consider all of the ways in which student loans are not at all like subprime mortgages.
First we need to look at who is doing the borrowing in each type of loan. Subprime mortgages are issued almost exclusively to inherently risky borrows, and the sum of money made available to those borrowers is generally quite large—in the range of hundreds of thousands of dollars. On the other hand, student loans are much smaller than mortgages in terms of total dollar amounts, and they are made to the full range of borrowers, not just risky borrowers. Yes, poor students tend to borrow more than wealthier ones, in part because Congress has set higher borrowing caps for poor students, and in part because poor and independent students frequently don’t benefit from having parents who saved or borrowed on their behalf (including through second mortgages, PLUS loans, personal loans, and loans against retirement savings). But it isn’t just poor students who borrow through the Stafford and PLUS loan programs. Approximately 25 percent of subsidized Stafford loans (intended for low-income borrowers) are made to students who come from families with incomes of $50,000 to $100,000 per year, and approximately 10 percent go to students from families that have annual incomes of over $100,000. Students and families who borrow through the unsubsidized Stafford loan program and the PLUS loan program tend to be wealthier than those who borrow through the subsidized program, so clearly many borrowers in the student-loan program are not high-risk borrowers.
Second, we need to look at the significant differences between a mortgage foreclosure and a student-loan default. In the case of a mortgage foreclosure, the borrower can walk away from the obligation, and the lender can reclaim the asset in order to mitigate at least a portion of the loss. However, in the case of a student-loan default, the student does not walk away from the obligation. There is this false assumption that if a student defaults on their loan, the taxpayer pays the bill, but nothing could be further from the truth. The only students who get to walk away from their debts are those who die, those who are declared permanently and totally disabled, and those who qualify for Congressionally mandated loan-forgiveness programs, such as those made available to teachers and some others who work in public-service jobs. It may take longer and cost more to collect on a loan in default, but the government does find borrowers who have defaulted, and it does collect the debt, plus significant penalties and fees. While this may present a seemingly unfair burden to students as compared to homeowners, the student in default still benefits from the asset (the education) whereas the homeowner in foreclosure or bankruptcy does not (he or she loses the home). A defaulted loan is not a forgiven loan, and since student loans cannot be included in bankruptcy proceedings, the large majority of student borrowers do repay the loan, including those who default along the way.
Third, unlike most subprime mortgages which do not generate revenue for the government, student loans issued through the Direct Loan program do. With the conversion to an all Direct Loan program, it will be the government that reaps the benefits of the 7- to 9-percent interest rates charged to students and parents through the Federal loan programs (of course, minus the cost to the government of borrowing money to issue the loans in the first place and of hiring contractors to run the loan program). Yes, those who qualify for subsidized Stafford loans are enjoying a temporary reduction in interest rates, but soon they, too, will be borrowing at 6.8 percent, which is well above current market rates. It is odd to me that in the 1980s, mortgages were at 13 percent and student loans were at 9 percent, whereas now mortgages are at 4 percent and student loans are at nearly 7 percent. While a student loan may be an unsecured loan to a bank, it is not an unsecured loan to the government since the government has the ability to hunt down a student in default and make him or her pay. The IRS may be the world’s best repo man.
Like many, I do worry about the burden students take on when they borrow to pay for college, but we must acknowledge that it isn’t just the principal that is difficult for students to manage. Compounding loan interest and fees can more than double the cost of college over the term of a student loan, and those interest and fee payments to the government bring no added value to the student’s educational experience. While Congress is asking colleges to lower their tuition and fees, I would urge members to also consider the benefits to students and parents of reducing Federal loan interest rates. The main benefit of a government-run student loan program is that the Congress is now completely in control of interest rates charged to students and parents. I do, however, realize that the government depends on interest payments from students and parents to subsidize other programs and that while lower interest rates would help students and parents who need to borrow to pay for colllege, it would hurt those who benefit from other government programs.
I share a concern about rising default rates, which are inevitable (but not necessary) when unemployment rates are high in general, and even higher among recent college graduates. But make no mistake that the default hurts the student far more than the taxpayer since the government ultimately collects on the loan. Sadly, scholarly research has demonstrated time and time again that default rates are highest among nontraditional, independent, low-income, first-generation college students, regardless of where they go to school or which major they declare. Without financial support from their families, these students generally need to borrow more, especially if they are supporting a family while going to school. Efforts to increase educational attainment among adults have been effective, and now there are more independent, first-generation students in college than ever before, which means that more students are borrowing more money than ever before.
Still, there is no reason for a student to default on a Federal student loan because the government, unlike subprime-mortgage lenders, provides a number of repayment options and benefits—including deferment, forbearance, and income-contingent repayment—to help struggling borrowers maintain a solid repayment and credit record. Yes, it costs more in the long run when a borrower takes advantage of extended payment terms or reduced monthly payments, but this beats the likely alternative, which is to not attend college at all.
What is particularly interesting to me is that we spend so much time talking about student loan defaults, as if the taxpayer is paying the tab (when, in fact, the taxpayer is not), but we don’t talk about policies that do require the taxpayer to foot the bill for otherwise gainfully employed individuals. The taxpayer makes hefty student-loan payments on behalf of many federal workers who receive loan repayment benefits as part of their compensation package, in addition to their regular salaries. In addition, the taxpayer repays the student loans for many teachers, despite the fact that we now have a teacher surplus due to tough economic times. And don’t forget all of those doctors and lawyers who benefit from public service loan forgiveness programs—funded by the taxpayer—since their debt significantly exceeds their earned income. Does this mean that doctors and lawyers who perform public service do not qualify as being gainfully employed? I support loan-forgiveness programs, but let’s be honest about the fact that wealthier students often times benefit from these programs whereas many disadvantaged students do not.
In the end, taxpayers are likely to spend far more to support a person through entitlement programs than they are to support a student through college, and the return on the educational investment is substantially higher than that of entitlement programs. We all know the saying: Give a man a fish and he eats for a day, teach him how to fish and he eats for a lifetime. Sure, some people need entitlement benefits, and we should provide them, but isn’t it better to provide an opportunity for an individual to become independent and self-supporting through education rather than to condemn him to a life of dependency?
It is good and right for the taxpayer to enable an individual to earn a credential, get a better job, enjoy a better life, and have the privilege of paying income and payroll taxes for decades to come. There are no guarantees that a student who has the chance to go to college will make the most of the opportunity, or that he or she will succeed, or that there will ever be enough jobs to employ every college graduate in their chosen field at a premium salary. Not every college graduate will earn a six-figure salary, and even those who do probably won’t earn that much in the first years out of college. But I am willing to pay the price and take some risk in order to give someone else the opportunity that taxpayers afforded me many years ago.