Who's To Blame For The Student Loan Repayment Crisis? Try The Program Itself

Over the years the federal government has done much to make student loan repayment easier, from letting borrowers extend their payment terms to tying monthly payment amounts to a percent of their income. It’ll let people miss an entire year’s worth of payments before putting the loan in default and even let defaulters get their loans back in good standing through rehabilitation.

If this kind of repayment flexibility seems remarkable, it is. No consumer loan even comes close to offering more generous terms, which is both frustrating and extremely puzzling to policymakers. How can some 43 percent of borrowers – approximately 9 million individuals – not be making payments?

It’s fashionable to blame student loan servicers except they work under performance-based contracts, which means they actually make their money getting and keeping people in stable repayment. And even if we could believe servicers willingly worked against students’ and the Department of Education’s interests, it makes no financial sense for them to push “bad” repayment options that bring in fewer dollars all so they can spend more money on outreach and assistance later when people fall back into delinquency.

The issue also isn’t being able to pay. Total borrowing for college has grown considerably but monthly federal student loan debt burdens are pretty much the same as they were two decades ago and income-based repayment ensures anyone’s payments stay affordable.

The problem is people lack incentives to pay. Loans are contracts but they depend a great deal on systems of rewards and penalties that encourage people pay up and on time. For mortgages and auto loans, banks do things like repossess assets when consumers stop paying and in cases like credit card debt, they use combinations of interest rate hikes and credit limit restrictions to discourage people from being consistently late payers.

Where are the incentives on federal student loans? Education isn’t an asset that can be repossessed. Paying down student loan balances doesn’t free up credit to buy other things and higher interest rates or limited future borrowing don’t make much sense since education is typically a one-and-done purchase.

If someone who’s financially struggling sees his situation as temporary, and it’s human nature not to bet against oneself, it’s often easier to forego the paperwork and back-and-forth calls with one’s servicer and take the late fee hit. It’s a standard cost-benefit analysis but one that’s lopsided in the case of student loans because having to choose among the confusingly large number of hardship repayment options available adds an additional cost to the mix.

The choice to do nothing is also aided by the lack of urgency the program instills. Knowing you have a full year to miss payments before risking collections calls or possibly wage garnishment favors waiting out the financial storm. Nobody believes they’ll be unemployed for an entire year.

Those who eventually realize the situation isn’t temporary learn, after connecting with their loan servicer, that months of missed payments and penalties can all be instantly wiped away. Why? Because the federal student loan program lets them retroactively suspend their loan payments for up to several years, and up to 12 months at a time, through deferment or forbearance.

Giving someone who can’t pay their bills the ability to suspend their payments and pretend it never happened makes the books look good but as policy goes is awful. It ends up encouraging the very behavior it’s supposed to prevent.

For those who don’t use these options – they can potentially extend the payoff term and result in higher monthly payments down the road – there’s income-based repayment, which also sanctions not paying on time. Penalties, fees and capitalized interest are basically irrelevant if you know how much you owe each month is capped and you’re either going to earn enough money down the road to comfortably cover these additional costs or have any outstanding balance eventually written off.

In the end, why so many aren’t paying their student loans today has less to do with bad servicing or unmanageable debt loads. Instead it has more to do with people having too many hardship repayment choices, too long of window to act and too many retroactive “escape” clauses that signal it’s okay to skip payments and ignoring one’s loan servicer.

There’s good reason for the massive investment in federal financial aid but the student loan program has become so un-loan-like that it’s guaranteed to fail by traditional performance metrics. If we want to reduce delinquencies and defaults, like every other type of loan there simply need to be real consequences for people who don’t make payments.

@EDAnalyst

NOTE: This post first appeared as an opinion piece in The Hill on 6/13/2016