This post is from the introduction of my report student loan forgiveness. A full copy of the report can be found on Kindle.
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The Introduction to Student Loan Forgiveness
A constant flow of official reports and news articles document the growing student debt problem. Standard & Poors found that student debt grew 10% per year since 2003 reaching $904 billion at the end of the first quarter of 2012. Student debt outstanding is now higher than credit card debt or automobile loans outstanding. A recent New York Times article highlighting the growing use of debt collectors to recover funds from defaulted student loans found that one in six borrowers were in default, the total dollar volume of defaulted loans was $76 billion, and that the Education Department paid $1.4 billion last year to collection agencies and other groups to collect defaulted student loans. A Wall Street Journal article analyzing government data compiled by the Treasury Department found that from January through August of 2012 115,000 people had funds from their Social Security check garnished to pay off student loans compared to 60,000 cases in 2007 and only 6 such cases in 2000.
The current generation of students is leaving school more highly leveraged than any previous one. While education remains a good investment for the average student borrower, some students will never be able to repay their student loans in full. Moreover, current bankruptcy law and procedures make it very difficult for borrowers with student debt to ever obtain a fresh start. There is some interest in policies that might alleviate student loan debt burdens. However, this interest is tempered by the concern that the provision of debt relief to student borrowers would impose large costs on taxpayers.
This paper considers the possibility of changing policies and laws in order to make it easier for some highly leveraged students who are experiencing substantial economic hardship to have some or all of their student loans forgiven. Three programs or policies – (1) the Income Based Replacement (IBR) loan program (2) the discharge of student debt in bankruptcy, and (3) the treatment of student debt in chapter 13 – are assessed.
My assessment of the IBR program reached the following conclusions:
· The primary purpose of the program is to prevent students from defaulting on their student loans by reducing loan payments in years that the student debt is high relative to disposable income. Under current rules, relatively few borrowers with chronically high levels of student debt relative to income will qualify for debt relief after 25 years.
· Some analysts are concerned the IBR program will motivate some students to borrow more. However, the amount of debt that is forgiven under IBR depends upon the lifetime income of the student borrower’s household, which is difficult to predict when a person is in school. A modified less generous IBR program that offered a lower level of debt relief rather than complete loan forgiveness would not create a large incentive for increased borrowing.
· The take-up rate for the IBR program will be smaller than anticipated. First, not all loans are eligible for the IBR program and borrowers who do not know the rules when taking out or consolidating loans will lose access to IBR benefits. Second, some borrowers will choose a 20-year consolidated loan over a 10-year loan that is eligible for reduced IBR payments. Third, most married borrowers will not choose to maximize IBR benefits by filling separate tax returns because this would increase their tax liability.
· Individuals with high levels of both student debt and other loans (non-secured consumer loans and mortgage debt) will often gain very little debt relief under IBR despite their high leverage.
My assessment of the impact of the bankruptcy code on student debtors reached the following conclusions:
My assessment of rules governing the discharge of student debt in bankruptcy:
· The rules governing the discharge of student loans in bankruptcy are highly subjective. While outcome differ across courts, in most cases even student debtors in extremely dire economic circumstances have a difficult time getting student loans discharged in bankruptcy. Since 2005, the stringent rules governing the discharge of student loans pertain to private student loans as well as government-backed loans.
· The rules governing the discharge of student loans in bankruptcy could be modified to provide limited debt relief to borrowers in extreme financial circumstances without imposing substantial costs on taxpayers.
My assessment of rules governing student debt in chapter 13:
· The 2005 bankruptcy law forced many student debtors to file chapter 13 rather than chapter 7. Many student payments can only make minimal payments on their student loans while in a chapter 13 payment plans. The combination of low payments on student loans and the fact that student loans are not discharged prevents student debtors from obtaining a fresh financial start in bankruptcy.
· The repeal of the chapter 13 means test would facilitate quicker repayment of student loans and benefit both student debtors and taxpayers. A rule that provides priority to student debt payments over other unsecured debt payments in chapter 13 bankruptcy will improve the status of student debtors and taxpayers and still leave creditors better off than they were prior to the 2005 bankruptcy law.
· Modifications to current bankruptcy law designed to help student borrowers will likely accrue to a less affluent group of borrowers than changes to IBR.
The goal of debt forgiveness policies both inside and outside of bankruptcy is to balance two competing objectives – the provision of a fresh start to debtors and fairness to creditors. The 2005 bankruptcy law resulted in bankruptcy becoming much more supportive of the rights of creditors and less concerned about providing a new opportunity to debtors. It is now especially difficult for individuals who borrow funds to further their education to obtain debt relief. Several policy changes, including both modifications to IBR and changes to the bankruptcy code, might provide modest debt relief to student borrowers, maintain strong incentives against default, and protect taxpayer interests.
The full report on student loan forgiveness can be found on Kindle. It is free for the five day period starting 10/29/15.
Student Loan Forgiveness:
Also, people might be interest in my new book on Kindle
Nine Essays on Debt and Your Retirement.
Nine Essays on Debt and Your Retirement.