In this edition of Card Hub’s “Ask the Experts” series, we touch base with a number of renowned education finance experts to examine possible solutions to the growing problem posed by private student loan debt.
Roughly 12 of the 20 million people who attend college each year borrow money to do so, according to the Chronicle of Higher Education. Given the rising cost of education and the stagnant job market, it’s not surprising that outstanding student loan balances currently exceed $1 trillion.
It’s also natural to wonder if student loans could become the next sub-prime mortgages. They’re relatively easy to get, after all, and the amount of unpaid debt is prodigious.
Income-based repayment, loan forgiveness, and debt consolidation options make that outcome unlikely, at least as far as federal student loans are concerned. But what about the $150 billion in outstanding private student loans – more than $8 billion of which is in default?
Not only are private student loan borrowers subject to the vagaries of variable interest rates and lender autonomy over fees, but they’re not granted the same repayment flexibility as their counterparts with federally-backed loans. In other words, there’s no real safety net when it comes to private student loans, and if borrowers don’t get good jobs right out of college, the funds that were supposed to be a gateway to successful careers could ruin their financial lives before they even get started.
That’s what led the Consumer Financial Protection Bureau (CFPB) to recently call for information on private student loans with the ultimate goal of presenting recommendations to policymakers. More specifically, the CFPB is seeking input on the following issues:
- How student loan burdens might impact the broader economy and hinder access to mortgage credit and automobile loans
- How distressed borrowers manage their student loan obligations
- What options currently exist for borrowers to lower their monthly payments on private student loans
- Examples of successful alternate payment programs in other markets and which features could apply to this market
- The most effective mechanisms for communicating with distressed borrowers
But why wait to see what they come up with when we can get a sneak-preview now? Why not help find a solution, especially since the economic impact of student loans extends beyond simply those who lend and borrow?
We asked the following student loan experts what they think is needed to foster a healthier landscape, and we’ll be sure to share what they have to say with the CFPB. You can check out each expert’s insights by clicking on their name or simply jump to our Takeaways section for a quick synopsis.
- Mark Kantrowitz – Publisher of FinAid.org and author of Secrets to Winning a Scholarship
- Betsy Mayotte – Director of Compliance for American Student Assistance
- Heather Jarvis – Chair of the American Bar Association’s Committee on Government Relations and Student Financial Aid
- Isaac Bowers – Senior Program Manager for Educational Debt Relief and Outreach at Equal Justice Works
Mark Kantrowitz has a unique perspective on the student loan market, not only as publisher of FinAid, but also given his position on the board of trustees for the Center for Excellence in Education and on the editorial boards of both the Journal of Higher Education and the Council on Law in Higher Education, among other accomplishments. As such, he has some definite ideas about what can, should, and ultimately will be done to fix the student loan market as well as which proposed ideas would be practically ineffectual.
For starters, while some pundits suggest that struggling student borrowers simply refinance their loans, that’s not really an option for private borrowers. The terms of private student loans depend on the borrower’s credit standing, you see, and people who are struggling to make payments are likely to have lower credit scores than when they started due to rising credit utilization as well as those very payment problems. Sure, neither federal student loans nor private student loans have pre-payment penalties – meaning you could conceivably take out a new loan to pay them off – but if the new loan’s terms are worse, what’s the point?
Other options are in order, and Kantrowitz took us through them, from steps to increase competition to the need for better disclosures.
“Private student loans tend to be credit underwritten [and] they’re made by two types of lenders: banks, who use customer deposits to fund the loans, and non-bank financial institutions that rely on the capital markets to make the loans. The capital markets are still largely frozen from the sub-prime mortgage credit crisis,” Kantrowitz said, adding that the number of institutions making private student loans has declined roughly 60% in recent years, with the vast majority of those remaining being banks. “One of the ways that there could potentially be some improvements is doing something to enable the non-bank financial institutions to re-enter the marketplace. Having more participants in the marketplace might help borrowers by providing them with more options, and perhaps even cheaper options.”
OK, but what is that “something” that will push non-bank financial institutions back into the private loan market?
“If Congress were to restore bankruptcy discharge, it would stimulate the lenders into offering more compromise, more options for financial relief to struggling borrowers,” Kantrowitz said. “From the lender point of view, if they don’t compromise with the borrowers who are struggling – who generally can’t pay back the loans – and that borrower then has the option of getting the loan discharged in bankruptcy, well at that point the lender has lost the loan and lost all their revenue. If they can identify the borrowers who are likely to get a bankruptcy discharge and offer them something short of bankruptcy discharge, they get to keep the loan. They won’t get as much revenue from that loan, but it’s something rather than nothing.”
Unfortunately, Kantrowitz says it’s unlikely Congress will restore the ability to discharge student loans in bankruptcy given its current political makeup. But why is it even necessary to involve politicians in the first place? Can’t lenders just use common sense and take what they can get rather than seeing borrowers default in droves?
Well, the fact that non-bank financial institutions fund their loans through securitization makes that tricky. Upon making student loans, these institutions transfer the loans’ titles into trusts, the shares of which are sold to investors. The lenders forfeit the legal authority to alter the terms of the loans in doing so, which means all of the investors would have to agree in order for payment compromises to be extended. That’s just not practically likely. Of course, the CFPB could conceivably buy the entire trust so as to institute payment plans and the like, but that could be a hard sell given the looming threat of a sequester and the country’s massive deficit.
This reality does present opportunity for deep-pocketed investors, however. If you could strike a deal to buy defaulted private student loans at pennies on the dollar, it figures you could turn a healthy profit simply by squeezing some sort of partial payment out of the borrowers. They might not have the funds to pay their total amounts owed, after all, but they could scrounge up some of it. Kantrowitz says he’s pitched this idea to several lenders, none of whom have actually gone through with it.
“The thing that I think is most likely to happen is better disclosures and better counseling rules because it doesn’t cost anything,” he added. “It doesn’t help borrowers in distress, but it does prevent new borrowers from getting into trouble. As far as the borrowers who are already struggling, I don’t see a lot of options for relief coming down the wire. There are some things that maybe could happen with the CFPB trying to stimulate improvement, but I don’t think anything like that is going to happen very quickly. It will take at least a year or two, and I don’t think it’s going to be a lot of relief.”
It will be interesting to see which of Kantrowitz’s ideas are ultimately put to action, as he is indeed one of the many industry insiders in talks with the CFPB about our options for the future.
“A lot of these loans are tied up in investment portfolios, and the terms of the loans can’t really be changed because of that,” she told Card Hub. “Nobody is saying they don’t want to pay, they’re just saying that they need a little help.”
Mayotte in turn theorizes that the CFPB will likely pursue changes to investment laws in order to give lenders a bit of leeway in working with borrowers without harming the interests of those people who own shares in student loan-backed trusts.
However, she also cautions against oversimplifying the student loan market’s myriad problems and trying to find a single magic pill to cure them. From Mayotte’s perspective, the struggles we’re seeing today are an amalgamation of economic forces, financial illiteracy, and misplaced expectations.
“Anybody who has too much education debt has a slightly different story,” she says. “For some people, it’s because they didn’t shop for college the way they would normally shop for another type of consumer good. Other people had higher expectations that may have been reasonable as far as what their salary was going to be when they took out the debt in the first place. … Other people, it’s bad luck. Other people, it’s a little bit of a combination of all of those things. For a lot of people, there’s a real lack of financial literacy education. And I’m not just talking about college students; I’m talking about today’s college students’ parents.”
Still, something must be done because a lack of action could have far-reaching, currently undeterminable negative consequences.
“If there isn’t some sort of relief provided, you’re going to probably see a lot more debt litigation, you’re going to see a lot more frustration, [and] you’re probably going to see a lot more consumers attempting the bankruptcy route – and some of them I think should do that,” Mayotte said. “There’s the whole conversation about student loans in general – not just private student loans, but education debt – affecting the economy down the road. It postpones marriage; it postpones people having children; it certainly postpones home buying; it affects career choices; it trickles down to the overall consumer spending. I think it’s going to continue to be a concern if the debt levels continue the way they are.”
In the meantime, Mayotte offers two very sage pieces of advice for student borrowers: 1) it never hurts to ask your lender what options are available to you; and 2) finish school, if at all possible.
People, it seems, merely assume there’s no help available without actually exploring whether or not their hunch is correct. Given the variance in the terms of private student loan contracts, it really is difficult to forecast exactly what repayment leeway you have. Besides, lenders are people too and if they have an ability to cut you some sort of break, they might be inclined to do so, especially since it might be financially beneficial to them.
What’s more, the data clearly shows that borrowers who don’t get their degree are far more likely to encounter payment problems than those who do. The reason is obvious: While a down economy might make it harder for many college grads to find work, having no diploma will not only make it that much more difficult in the short-term, but they’ll also have fewer options once the landscape improves. Plus, taking out a student loan and not graduating is like paying for a meal at a restaurant without actually eating what you ordered. It just doesn’t make sense in non-emergency situations.
In addition to serving as the chair of the ABA’s Committee on Government Relations and Student Financial Aid, Heather Jarvis operates a website aptly named AskHeatherJarvis.com, through which she regularly interacts with student borrowers, offering whatever guidance she can in this constrictive landscape.
So, what advice does she have? Here’s how she sees things for both borrowers and the CFPB:
“In terms of what people can do right now if they’re facing a situation with private student loans, the answer is only what is reflected in your contract with the private student loan company. The terms vary quite a bit. When I speak to people about their private student loans, I always suggest that they take a look at the promissory note and read it because sometimes there are provisions in there that can be helpful. People should pursue those options insofar as there are any, which is not to say that they’re great usually. Then, in terms of what else can be done about private loans, I think it’s very encouraging that the Consumer Financial Protection Bureau is looking into what can be changed because the lenders who have these loans could choose to modify the repayment terms if they wish. They have the authority to do what they want to do with these contracts.”
What about the limitations posed by securitization? Jarvis has an interesting outlook on that too, arguing that the lack of options in the private student loan market is a natural byproduct of its true purpose.
“It really does underscore what advocates for borrowers like me have been thinking and saying for years, which is that these loans really never were created exclusively to be a consumer borrowing tool that was of use to the person who was getting the money,” she told Card Hub. “Certainly they have been of use in certain cases, but they really have also been marketed aggressively to borrowers because of investor appetite in those products. That is disturbing, and it does raise red flags in terms of the terms of the loans being designed to be pro-investor, and that is sometimes counter to the interests of the borrowers in a way that is not always fair or transparent to the people who are doing the borrowing. I’ve got to say, I’m not sure to what extent the argument that they don’t have the authority to change the terms because of their investors is entirely true. There’s bound to be more than one way to look at that question, and if there are some roadblocks to modifying the loan terms, then that’s what we need to fix.”
The question, of course, is how to do that.
The CFPB’s public filings show that more than $4 billion in private student loans were collateralized in 2012. Well, according to Bowers, the CFPB could unlock such securitized loans by essentially turning them into federal student loans, which are far more flexible.
“Our initial thought is probably what would be most helpful for borrowers is giving them the funds to pay off their private student loans and replace them with federal student loans,” he said, adding that political dynamics, not the money involved, will likely prevent that from actually happening. “The projections we’ve read have shown that depending on how you did it, a refinancing option like that where the federal government took on those loans would actually probably make the federal government money in the long run. So, I’m not sure if it’s a question so much of the funding not being there as the political will not being there.”
Don’t worry too much if you’re in favor of that plan, though. Bowers, Equal Justice Works, and its “allies” are working to drum up support for this federal refinance scheme.
- Problematic student loan debt has far-reaching economic implications: If you can’t pay off your student loan, you’ll probably have to also put off buying a house or a car, starting a family, etc.
- Securitization of private student loans prevents repayment options: Lenders are often powerless to alter the repayment terms of private student loans, as they’ve been rolled into trusts and permission of all the investors would be required.
- Congress could promote competition and compromise by allowing student loans to be discharged in bankruptcy: If lenders knew that bankruptcy discharge was an option for student borrowers, they’d be inclined to offer payment plans and offers in compromise.
- Purchasing entire pools of private student loans would give the buyer the authority to offer amended repayment plans and potentially turn a hefty profit: If you’re able to buy defaulted student loans on the cheap, any money you eventually recoup through amended payment plans could quickly become profit. Congress or the CFPB could provide the funds to unlock securitized private student loans and essentially convert them into federal student loans, but even though doing so might be financially beneficial, the political climate makes it unlikely.
- Struggling borrowers should always examine their student loan contracts with a fine-tooth comb as well as ask their lenders what repayment options are available: Borrowers who encounter payment problems too often assume there’s nothing that can be done to improve their situation. But it really doesn’t hurt to do a bit of research or ask someone. Your hunch might prove true, but then again it might not.
- Don’t stop opening your mail: it’s common for delinquent borrowers to stop opening mail from their lenders, thinking the envelopes contain only past-due notices. However, those notices are often accompanied by literature about repayment options and other helpful resources.
- Better disclosures and revamped counseling rules are the most likely student loan market changes: These steps will help prevent future borrowers from getting into trouble but will do little to alleviate the struggles of those currently having trouble with repayment.