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Forbes: Student Loan Crisis Solved -- Next Problem?

Raj Sabhlok, Contributor

Economists fear we’re racing towards another trillion dollar bubble of student loan debt. But there is a simple way to stop the madness now, before we blow any more taxpayer dollars — or our kids pay an even bigger price.

If financial history has taught us anything, it’s that high levels of debt and, more specifically, bad loans lead to financial crises. We have seen this numerous times including the Asian Debt Crisis in the late 90s, the more recent Greek Debt Crisis and, of course, the U.S. subprime mortgage debacle.

Financial crises have often been linked to government monetary policy. Arguably, the U.S. government was at least complicit with “easy money” credit policies that led to the housing boom and bust, which in large part triggered our most recent financial crisis.

Unfortunately, we are heading for another government-induced financial crisis — this time it is the $1 trillion in student loan debt. As of 2010, about one in five households in the U.S. have student loan–related debt of over $26,000. What is saddest about this pending crisis is that it will likely impact millions of student borrowers throughout their lives, because unlike credit card debt or mortgage debt, student loans can’t be discharged by bankruptcy.

How did we get here?

Ironically, as this crisis races toward a financial cliff, there has been no action by the government to curtail student loans, as would be the case in any other debt-related financial crisis. In 2011-12, the federal government issued 93 percent of all student loans.

Student loans are unique for a number of reasons, none perhaps more glaring than the fact that virtually nothing can disqualify an applicant from a federally-backed loan, excluding a prior student loan default or a drug conviction. A student loan is quite possibly the only loan that is not tied to credit worthiness or the ability to repay. Even more frustrating is that these easy loans are correlated to the rising cost of college — colleges have every incentive to raise costs knowing that there is an endless money supply.

Stop the madness

This crisis will likely end badly for the millions of student borrowers steeped in debt and with no ability to repay. For some reason, the government believes that everyone should go to college and is willing to give students any amount of money to put them on that righteous path. Inexplicably, this is all happening with no regard to whether students will be employable upon graduation or how they will pay back these monstrous loans. This madness must stop.

Like any loan, there needs to be some element of credit worthiness as William Bennett suggested last week in his article, “The looming crisis of student loan debt.” But one might ask, how can an unemployed student be creditworthy?

A simple solution

Admittedly student loans are riskier than most since there is no tangible asset to collateralize (although there certainly is a non-tangible asset — the student’s education). However, all educations are not created equal and should be “appraised” by lenders as part of a student loan determination.
College fees and student loan debt have a perverse symbiotic relationship. Rising costs in education beget rising student loan debt. It is puzzling why an art degree costs as much as a computer science degree when the job prospects of each are so vastly unequal.

Lenders, in this case the government, should make a fact-based determination of a student’s likelihood to graduate, to get a job and their expected income. Prospective students applying for loans can be evaluated for “credit worthiness” based on a score much like a FICO score. A student loan score would be based on a formula comprising their grade point average, major, and academic institution. Each of these variables is directly related to a student’s ability to get a job upon graduation and repay their loans. For example, a STEM (science, technology, engineering and mathematics) major at MIT would yield a higher score and loan compared to a religious studies major at a lesser ranked school.

While the solution I have outlined doesn’t offer relief to those deeply in debt today, it will stop more hot air going into the student loan balloon. And although I agree that everyone should have the right to go to college and study whatever they’d like, our government and colleges shouldn’t be reckless with our youth’s financial future — or taxpayer dollars.

Copyright 2012 Forbes.com LLC. All rights reserved.

Student loan debt strategies

As many readers of this blog are aware, defaulted student loans are generally not dischargeable in bankruptcy except in special circumstances. The debtor must show that: (1) he or she cannot maintain, based on current income and expenses, a minimal standard of living for the debtor and dependents if forced to pay off the student loan; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loan; and (3) that the he or she has made good faith efforts to repay the loans. That was the holding in Brunner v. New York State Higher Education Services Corp., 831 F.2d. 395 (2nd Cir. 1987), the leading case on student loans and bankruptcy, and its reasoning has been adopted by most federal appellate courts.

However, non-bankruptcy remedies are available under federal and state law for student loan debtors, including loan consolidation, deferment or forbearance:

1. Loan consolidation. Most federal student loans (except private loans) are eligible to be consolidated. However, if your loans are in default, you must meet certain requirements before you can consolidate your loans. Loan consolidation greatly simplify loan repayment by centralizing your loans to one bill and can lower monthly payments by giving you up to 30 years to repay your loans. You might also have access to alternative repayment plans you would not have had before, and you'll be able to switch your variable interest rate loans to a fixed interest rate.

2. Deferment. Deferment is a period during which repayment of the principal balance of your loan is temporarily delayed. Also, depending on the type of loan you have, the federal government may pay the interest on your loan during a period of deferment. The government does not pay the interest on your unsubsidized loans (or on any PLUS loans).

You are responsible for paying the interest that accumulates during the deferment period, but your payment is not due during the deferment period. If you don't pay the interest on your loan during deferment, it may be capitalized (added to your principal balance), and the amount you pay in the future will be higher.

3. Forbearance. If you can't make your scheduled loan payments, but don't qualify for a deferment, your loan servicer may be able to grant you a forbearance. With forbearance, you may be able to stop making payments or reduce your monthly payment for up to 12 months. Interest will continue to accrue on your subsidized and unsubsidized loans (including all PLUS loans).

There are two types of forbearance: discretionary and mandatory. For discretionary forbearance, your lender decides whether to grant forbearance or not. For mandatory forbearance, if you meet the eligibility criteria for the forbearance, your lender is required to grant the forbearance.

For more information about possible solutions to coping with your student loan debts, please contact Jim Shenwick