A Roadmap to Student Loan Reform

5 Bold Ideas from the Democratic Primary


Last week, Trump announced a 60-day suspension of student loan interest and payments. Though this will provide needed relief to those affected by the sudden and swift economic downturn, it does little to fix the larger issues within the federal student loan program.


Even before the current economic shock, the student loan system had significant issues according to the Federal Reserve:

  • 20% of borrowers are behind on their payments

  • Only 40% of borrowers are making on-time payments


Student loans have the highest delinquency and non-payment rates of any kind of debt in the US. In total, 45 million Americans collectively owe over $1.6 trillion to the government - making student debt the largest source of debt for most Americans.


If previous recessions are a guide, we are likely to see a spike in school enrollment as people weather the depressed job market and seek to gain new skills to become more employable.


For the next generation of students, what can we do today to fix the broken student loan program?


Here are 5 bold ideas that have come out of the Democratic primary:


1. Loan Forgiveness

It’s no coincidence that Bernie Sanders and Elizabeth Warren garnered significant attention by proposing to forgive student debt. Many critics have (rightly) argued that these proposals amount to a give-away to well-off, upper middle-class doctors, MBA and law graduates who proportionally owe and earn the most.


However, some level of loan forgiveness is likely to be part of any reform of the student loan market. This is because those who owe the smallest amounts are the most likely to be behind on their payments: 1-in-3 people without a degree are behind on payments vs. 1-in-10 graduates with a bachelors. Many of these students dropped out of college before graduation - leaving them with all of the debt of a degree without any of the earnings benefits of a diploma.


It’s a frustrating feature of the program to see many of those with the smallest outstanding balances struggle the most. Forgiving the first $10K, $15K, or $20K in loan balance, especially undergraduate loan balances, will benefit everyone - but specifically target those most likely to be behind.



2. Universal interest rate reductions

The Federal Government currently enjoys the lowest borrowing costs ever - the 10-year Treasury is below 1% and the 30-year year Treasury dropped below 1.5%. However, students often pay interest rates in the high single-digits. These rates are set at the beginning of the loan and are fixed during the entire loan term.

In this hypothetical example, cutting a borrower’s interest rate in half from 6% to 3% on a $10,000 loan would help the student save $15 a month and $1,700+ over the life of the loan.


Lowering student borrowing rates for everyone (and not just on new loans) to reflect the unprecedented low cost of federal borrowing would give all 45 million borrowers thousands of dollars back in disposable income. This would allow millions of people to better weather the current financial shock and take up deferred big life plans like home ownership. It would also give many more a pathway to repaying their loans years sooner than they currently anticipate.



3. Revamp income-based repayment plans

Moderate Democratic candidates such as Michael Bloomberg and Joe Biden have put forth comprehensive plans to simplify the complex menu of income-based repayment plans that currently exists.


This includes cutting the cap on student-loan payments by 50% to make monthly payments more manageable. Simultaneously, all outstanding loans would be forgiven tax-free, potentially as early as 15-years. Currently, the IRS treats loan forgiveness as taxable income - causing a huge taxable event for many borrowers just as they believe they’ve finished paying back the Federal Government. Many existing income-based repayment plans stretch payments out up to 20-years (undergraduate) or 25-years (graduate), or longer in instances of forbearance.


By making income-based repayment plans more manageable for borrowers, student loan debt would no longer be a heavy anvil that prevents people from pursuing other goals. Financial goals like home ownership or retirement savings are beneficial both for individuals and the greater economy.


4. Institute underwriting best practices, focusing on a forward-looking, ability-to-repay look at one's risk

Today, there is little-to-no credit risk assessment done on federal student loans - everyone is eligible for loans as an entitlement irrespective of one’s ability to repay their loan back. This is how we hear of young students borrowing tens of thousands of dollars only to realize they have no ability to ever pay it back. We handicap young Americans before they even start their career.


Calculating one’s ability-to-repay is a cornerstone of every sound credit market, ranging from credit cards to mortgages. What might an ability-to-repay requirement look like for student loans?


Forward-looking credit model

Because young Americans are at the start of their credit journey, lending would need to take a forward-looking, rather than backward-looking, view. This ability-to-repay would focus on forward-looking data points tied to student performance outcomes, such as: graduation rates, post-graduation employment rates, and expected entry-level and mid-career salaries based on the school’s program and national statistics. Schools would be heavily incentivized to focus on student performance to increase the amount of lending aid their students could receive. This forward-looking model is similar to what innovative student fintech lenders like Prodigy Finance and MPOWER Financing use today (full disclosure, my current employer is MPOWER).


Provide an explicit student loan entitlement

The implementation of ability-to-repay rules could be done in combination with preserving the open-ended entitlement that exists today. Every American, for example, could be eligible for a certain amount of student loan funding they can use before ability-to-repay kicks-in. For example, everyone could get $15,000 in federal student loans above which more substantial underwriting would occur. This would prevent borrowers from getting mired in too much debt relative to their anticipated income.


By focusing on student outcomes rather than institution designation, this side-steps the contentious for-profit vs. non-profit education debate - for-profit schools with strong student outcomes would get funding, just as non-profit schools with low student outcomes wouldn’t.


Lastly, the ability-to-repay underwriting and administration of the federal student loan program could be done from a separate public benefit corporation. If we look to the mortgage market for inspiration, the GSEs (Freddie Mac and Fannie Mae) have proved to be strong actors and facilitators in deepening credit markets while giving its profits to the government.


5. Expand public options

An astounding 99% of applicants to the Public Service Loan Forgiveness program have been rejected. Democratic front-runner, Joe Biden, proposes recrafting the program to offer $10,000 in annual debt relief for every year of national or community service, up to five years. Further, the student would be automatically enrolled in such a program and previous years of service would be grandfathered in. Revisioning the public service program is a clear way of providing student loan relief to people whose efforts provide the government and social sector needed labor and skill sets.


Changes in the federal student loan program can be made in conjunction with other higher education reforms. Across the Democratic field, there is a consensus of making public universities debt-free, especially for students from lower-income backgrounds. This can be done in part through the expansion of PELL grants, especially for vulnerable populations like New Americans, Dreamers, and the formerly incarcerated.


Conclusion

Business as usual is not an option for the federal student loan program. With the number of people expected to go back to school to swell during the next recession, big reforms are needed to advance America’s long-term economic interests.


Bold ideas - loan forgiveness, universal interest rate reductions, instituting underwriting best practices, revamping income-based repayment plans, and expanding public options - should all be among the bold ideas considered by the next administration.

 
 

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