This is a guest post by Karen Gordon. Karen is a writer/blogger for the financial industry. She has more than 18 years of experience in management and public relations. Karen currently works for Zoot Enterprises, a global provider of advanced loan origination, account acquisition, and credit risk management solutions.
Rising student loan debt (currently estimated at $1 trillion) and defaults are grabbing today’s headlines. Instead of being dominated by the mortgage crisis, now it’s the student loan debacle. It makes me take pause and consider whether we learned anything from the housing crisis. The answer is clearly no. It’s admirable to want everyone to be able to own their own home and for everyone to have an equal opportunity to receive a college education. The reality is it doesn’t make good business sense to meet these goals by lending people outrageous amounts of money without considering their credit history or ability to repay the loans. If we truly value education in this country, we should start by educating people about personal finance and responsibility.
Learning from Personal Experience
I was an undergraduate student in the late 80’s. As the first person in my family to ever attend college, there wasn’t anyone to guide me in the process. I was accepted to a private school that was more than willing to help me finance my education. Every fall I signed my financial aid paperwork and happily attended my classes. Five years later I earned my bachelor’s degree then reality set in. I had significant debt to repay on a new graduate salary. For 10 years I made the minimum monthly payment at 8 percent interest until they were paid off, an even bigger “ouch”. I learned my lesson the hard way that just because money is offered to you, it doesn’t mean it is a good idea to take it. When I returned to graduate school, I understood the ramifications of taking out too many loans. This knowledge helped me graduate with a manageable debt to repay at a very low interest rate (1.35 percent). My student loan debt has been fully repaid, but I know many people who are still overwhelmed by theirs.
The Current State of Student Loans
Here are the facts that are responsible for the mounting student loan crisis today. In 2009, the Student Aid and Fiscal Responsibility Act (SAFRA) ended the origination of federally funded education loans through financial institutions, and limited new servicing awards to four providers: Sallie Mae, Nelnet Services, American Education Services/Pennsylvania Higher Education Assistance Agency, and Great Lakes Educational Loan Services. This federal lending program was designed to make college education available to everyone. Stats from the Federal Reserve Bank of New York show payments on 11 percent of student-loan balances were 90 or more days behind at the end of September, exceeding the delinquency rate for credit cards. Delinquency rates for all other consumer-debt categories fell or were flat, during the same time period. The Wall Street Journal recently reported that the federal government issued 93 percent of student loans in the 2011-2012 academic year, asking little or nothing about borrowers’ ability to repay, or about the education they intended to pursue.
Whether too many student loans were made by the government without properly assessing the risk, or people feel a sense of entitlement that they don’t need to repay the loans so freely given to them, doesn’t really matter. The damage has already been done. There is much to be learned and just like we learned from the mortgage crisis, not everyone should be given student loans. Congress may soon be presented options to overhaul student loan collections with automatic withdrawals from borrowers’ paychecks linked to their incomes. Wisconsin Republican Representative Tom Petri, who plans to introduce the bill, says 98 percent of borrowers could meet their loan payments through automatic payroll withholding. Payments would be capped at 15 percent of borrowers’ income after basic living expenses. This seems like a good start toward recovery, but more needs to be done from a proactive stance.
The Way Forward
New start-ups in the student loan industry may be on to something proactive. CommonBond is a program that connects student borrowers with alumni investors to offer lower interest rates for both new loans and the refinance of current loans. While it is only offered at the Wharton Business School today, the program plans to spread across schools nationwide. The part of this loan program I find the most impactful is that it provides a network of alumni professionals who connect students to professional opportunities. With the loan money coming from investors, there is a huge incentive for them to help these graduates find jobs to get a return on their investment. The program’s website proclaims, “Once you join the CommonBond Family, we’ve got your back.”
There are many common sense things students could do to proactively reduce their expenses. Get residency prior to attending an out-of-state school, borrow textbooks from people who have already taken the class, look for loan forgiveness programs (often available to teachers, social workers and medical personnel who commit to working in their field of study or in a particular location for a set number of years) and take advantage of interest reductions for auto-pay and bonus interest reductions after you have made an established number of consecutive on-time payments. Students could also subscribe to the Dave Ramsey school of thought: don’t go to school until you have enough money to pay for it.
The idea of having a personal stake or investment, as with the CommonBond model, leads me to one final thought on this subject. While I wish I had received more guidance in planning for my undergraduate education, what I did have was a personal investment. I paid for every penny of my higher education (and paid back every penny I had to borrow). That investment is what drove me to do my best both in school and when I entered the professional world. If students were required to maintain a certain GPA to keep their loans (as many scholarships and curriculum already require) or invest some type of equity as a down payment (either monetary or a commitment to work a specific number of hours) for their educational loans, would there be a greater investment in their repayment?
We need to focus on the next generation of students to help them not fall into the same trap. That begins with teaching personal finance education and responsibility.
Image credit: Advantagecanada.ca.