Special Report: Digging into Debt: How Student Loans are Burying Borrowers

The U.S. is facing an economic crisis at the hands of a system built to help the country grow.

Student loans have been a boon to college students for decades. Using the loan system set up by the federal government, many low-income families have been able to gain higher education.

In theory, this should mean a plethora of educated workers on the job market earning more money for every year of school they complete.

In practice, student loan debt has grown to a dangerous level, threatening the social and financial stability of the U.S.'s younger generations.

The average loan amount for a U.S. student is about $29,000, but more than one-quarter of student borrowers have $50,000 or more in debt. The number of students who can pay that amount back is quite low.

student borrowers

The total U.S. student loan debt reached $1.2 trillion in 2015, and it's only getting bigger...

Debt for Days

Student loan debt has surpassed credit card loans and auto loans in the U.S., now only trailing behind mortgage debt. What's more, it is the only kind of consumer debt not decreasing.

The main problem with this trend is the growing number of people in default — those who have not made a payment on their student loan in nine months.

As of the third quarter of 2014, the three-year default rate for the U.S. was about 13.7%. Below you can see the summary of federal loan defaults for the time period:

fed loan defaults

On the government's end, it's rare that the full amount of a defaulted loan is ever collected.

This kind of debt can restrict a prior student's funds, keeping them from saving for retirement in the future and holding them back from starting families or buying houses.

Society Pays

One survey by Bankrate found that 45% of Americans with student loan debt have had to put off important life milestones.

For instance, between the first quarter of 2005 and the first quarter of 2015, homeownership by Americans under 35 dropped from 43.3% to 34.6%.

One survey found that over half of first-time homebuyers that reported trouble saving for a down payment had this problem due to student loan debt.

Car sales, too, have been dropping among the younger crowd. One article compared the number of Gen X and Gen Y (millennial) buyers in 2014 and found that Gen Y was about 27% less likely than Gen X to be purchasing a new car.

This correlates with a stable used car market and an increase in car rentals or leases in 2014. When a new car is out of a prior student's price range, these are often the next best options.

According to the Centers for Disease Control, the median age for women giving birth for the first time is 26 as of 2013, and it's still rising as families are put off. The rates of birth for women aged 20–29 (the healthiest range is generally agreed to be between 20–24) are at record lows.

And so, with millions of dollars going toward student loan debt every year, that's millions of dollars not being put back into the real estate, car, or consumer products markets.

The best a former student can hope for from such high debt is a decent credit score — if they can afford the long-term payments.

If a student can't afford those payments, their wages can be garnished and tax refunds can be refused.

The mother of one of our own writers hasn't seen a tax refund in more than a decade owing to more than $20,000 in loan debt, and her credit is ruined — she can't co-sign on any big family purchases, their newly-bought house included.

In situations like this, a student's credit score can be destroyed, hurting their chances of ever having the financial health to buy a home, a car, or to start a family.

This kind of fear can even scare younger people into not going to school at all, which is an outcome that would only hurt the economy more.

But rather than imagine the worst-case scenario, let's look at how history has brought us to this point...

Who Dealt This Mess?

The first major problem facing students is the drastic rise in tuition over the years.

Once, a part-time job at minimum wage would pay for a four-year education.

But today, a part-time 20-hour workweek at the minimum wage of $7.25 an hour would take five full years to pay off the average cost of tuition, $35,000 — and that's if all of that money went to tuition, not housing, transportation, or food.

Since the first government record of tuition rates in 1978, the price of an education has skyrocketed more than 1,120%.

Just between 2008 and 2012, the cost of attending a public university rose by 27%, and from 1992 to 2012, the cost of tuition rose 1.6% faster than inflation every year.

In contrast, the U.S. federal minimum wage has only risen about 174% since 1978, from $2.65 to $7.25.

It has, in fact, lost value as compared to inflation. If adjusted into 2014 dollar values, the minimum wage in 1978 was about $9.51, and it now stands at about $7.80.

So the amount people must pay into tuition and the amount they are being paid while going to school are drastically different, and many students find it difficult to balance the two.

When no payments have been made toward a loan in nine months or more, the loan goes into default. At that time, the entirety of the loan amount becomes due at once.

Should the student continue to not pay or not refinance the loan and begin a new payment plan, the loan becomes delinquent after 90 days. This is when the tax and wage reclamations begin.

However, there have been some problems in defining exactly how much of the U.S. student loan debt is coming from delinquent loans.

As of June 30, 2015, it was reported that seriously delinquent loans accounted for 11.5% of all student loans. But here are a few other factors being brought forth that claim this is an understatement.

You see, only 37% of students with loans are actually in the repayment stage and paying on time. About half of the students with loans are still in school and therefore are legally putting off payments; their balances will begin being due six months after they leave school.

So with about 50% of those loans not due yet and 37% being paid regularly, the actual amount of delinquent loans could be as much as 23% of all student loans.

This discrepancy makes it difficult to know exactly how much money is being charged right now and how bad the level of unpaid loans really is.

Another major problem is the process of reclamation for these loans.

As noted above, the government can garnish wages — payments are taken straight from the former student's paycheck before they even see the money — or simply claim any possible tax refunds the former student may have earned.

The problem with this system is two-fold: It causes extra work for the IRS, who keeps track of all of that money, and it minimizes the amount of money a student loan holder sees.

And worse: Students often find it easier to let this happen than to pay off the loan in installments themselves.

Take, for instance, our writer's mother. With a family of five to take care of, she would not be able to afford the monthly payments of 10% to 15% of her income that a wage-weighted payment plan would require.

Therefore, it's easier for her to just continue to relinquish her tax refunds.

In many debtors' eyes, this is safer than defaulting on other kinds of loans because there are no other collateral assets that can be seized by the lender, and interest rates on student loans don't rise in response to bad payment habits

Unfortunately, this circles back to the fact that the government rarely collects the entirety of a defaulted loan; those claimed tax refunds may cover the interest of a loan but may never repay the full amount.

No Assistance From the Job Market

The biggest problem facing potential college students today is that they almost cannot avoid getting a college education.

Bachelor's degrees are increasingly necessary for mid- and even entry-level jobs. As mentioned above, a minimum-wage salary isn't enough to live on and pay student loans in a timely manner, and so better jobs with higher education requirements are a must.

The National Center for Education Statistics offers this straightforward chart showing the median annual earnings of full-time, year-round workers between the ages of 25 and 34 from 2000 to 2013:

earning of workers 25-34

It's obvious that a higher education will earn a higher salary... but at what cost?

Some professions can take advantage of what is colloquially called the “doctor's loophole.” Officially, its title is the Public Service Loan Forgiveness Program.

This program states that the former student must work in a public service position, such as a government organization or a non-profit, for 10 years while making regular monthly payments for 120 consecutive months. If the student does this, their remaining balance after 10 years will be forgiven.

Many in medical and legal tracks in college can qualify for these positions in public service, and because these lines of study often cost the most, it would seem to make the most sense that they would have this opportunity.

However, these career paths also end up making the most later in life. After 10 years of public service, a medical or legal student may have gained enough experience to find a six-figure job that would have paid the last of their loans in full.

Instead, large portions of those loans will be forgiven, despite the potential for a high-paying career. This program was signed into law in 2007, and in 2017, when the first qualifying loans are forgiven, it's estimated that the U.S. government will have to cover the cost of the remaining balances.

It's estimated that beginning in 2017, the program could cost the country as much as $11 billion per year in student loan forgiveness.

And of course, not everyone can even qualify for this kind of program, leaving millions of students to pay bills just as high without much hope of forgiveness.

For other career tracks, it's possible for former students to have their loans forgiven if they make regular monthly payments consecutively for 25 years. The monthly payments can be based on their income, usually just 10% to 15% of what they earn.

The main problem here is that this plan only takes into account the borrower's discretionary income; if they happen to have above-average medical bills or a family to take care of, even that much every month could be too much.

Preventative Measures

Several ideas have been suggested to help stop the growth of crippling student debt in America.

One that is already in practice is the Cohort Default Rate system. Under this system, the Department of Education evaluates schools once every year to determine how many students with loans have withdrawn from the school and defaulted on their debt.

If that number happens to be over 30% of the school's overall borrowers, that school will lose its access to federal student loans. This helps identify schools with high rates of default and stops them from building up excess debt.

However, it does not help the students at all.

President Obama recently announced his plan to cover the cost of community college for students who can maintain good grades.

This would certainly provide a better incentive to complete the degree. Another concern haunting the student debt problem is that many students in default did not complete their schooling, meaning they are in massive debt with nothing to show for it.

A program like this would at least leave students only two years at a public university to pay for, rather than the full four years.

Some California students have lobbied for a loan system more similar to that of the UK.

An interview with the director of the UK Higher Education Policy Institute Nick Hillman revealed that the UK and the U.S. have a couple of similarities in their student loan borrowers: both can have loan payments taken directly out of their paychecks, and both are of the opinion that this is the best way to have it done.

However, unlike in the U.S., those amounts are not crippling. In fact, in the UK, loan payments are only taken out of a former student's paycheck when they get a job that pays at least £21,00 ($33,000) per year, and only 9% of any amount over that is taken out.

There are no bills in the meantime; the loan sits calmly — still accruing interest, of course — until the borrower makes enough money for the monthly payments to be removed from their payroll.

It doesn't hurt that the UK also has a cap on tuition; universities are only allowed to charge up to £9,000 ($14,000) in tuition per year, unlike U.S. colleges, some of which charge more than that per semester.

Someone's Got to Get Paid...

Until a legislative solution is found, it's likely that this debt will just keep growing. The number of students is not decreasing; in fact, as of fall 2015, the rate of yearly enrollment has increased by just about 5 million students.

As such, the ones who will be able to profit from the situation will be loan servicers.

One example is Nelnet Inc. (NYSE: NNI), which offers loan refinancing services, access to repayment plans, and even options for disabled borrowers.

This small company was servicing more than $146 billion in loans on behalf of the Department of Education, accounting for 5.9 million borrowers.

And they'll keep making that kind of money until the U.S. finds a better way to fund its millions of college students.

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