If you are a lending institution that loses money on the loans that you make, it's an understatement to say that changes are required. Unfortunately, that's the upcoming position of the federal government with respect to student loans.
While student loan debt has spiraled upward to top $1.4 trillion, the government's return on that investment is following an opposite spiral. According to the annual financial report from the U.S. Department of Education, the student loan program is expected to leave the government $36 billion short of the funds needed to handle existing student debt obligations and accrued interest.
The annual report represents a rapid change in fortunes for the student loan program. Last year, the Department of Education projected an $8.4 billion shortfall, after years of projecting surpluses. Such a trend cannot be ignored.
What happened to the rosy projections? Overoptimistic projections on interest rates, interest income, and default expectations are part of the problem. However, a large part of the changes may be traced to a recent explosion in borrowers signing up for income-driven repayment (IDR) programs.
IDR programs allow borrowers to restructure their student loan debt to fit with their current incomes. The programs limit the monthly payments to anywhere from 10% to 20% of discretionary income depending on the choice of program. If the loan is still not paid off after 20-25 years (depending on the plan choice), the outstanding loan balances are forgiven.
Borrowers with higher loan balances are signing up for the program in larger numbers than lower-income borrowers who tend to borrow lower totals, increasing the collective amount of projected write-offs at the end of the term.
In 2013, approximately 1.6 million student loan borrowers were enrolled in IDR programs, constituting $72.3 billion in loan balances. The current numbers have ballooned to 6.5 million borrowers and $352.5 billion respectively.
A separate report from the Education Department's Office of the Inspector General projects that the government loaned out $11.5 billion more money in IDR plans than the loan recipients will pay back. That's a massive 748% increase from the $1.4 billion differential from 2011.
Student loans are unique in one aspect. They are the one form of loan where the risk of an individual borrower is not considered. It shouldn't be a surprise that student loan delinquency rates are relatively high – around 11.2% of student loan debt in the repayment stage is either ninety days delinquent or in default.
The expansion of income-driven programs was intended to prevent default rates from rising among lower-income borrowers, theoretically producing savings for taxpayers. However, the losses from the massive amount of funds being directed into repayment programs appear to be swamping any positive effects of reduced default rates.
The government is almost certain to make changes to the student loan program, even though the changes are likely to be highly unpopular with constituents – and neither the legislative nor the executive branch has the best record of setting fiscally responsible policies. Anything from a reduction of income-based repayment options to caps on total borrowing amounts may be on the table. President Trump’s recent budget proposal called for narrowing income-based loan repayment plans from four to one, as well as ending the Public Service Loan Forgiveness Program.
If you are heading off to college in the near future, expect to have a more difficult time acquiring student loans and fewer attractive options to pay them back. Look at your educational costs as a return on investment, and choose your school and curriculum wisely. Increase the odds of being able to pay back any amount that you borrow with minimal or no government assistance.
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