A sensible solution to student loan debt

The college class of 2010 now has a dubious distinction. Its graduates who had student loans owed a record-high average of $25,250, up 5.2% from the previous year, according to a new report from the Project on Student Debt, a nonprofit advocacy group.

Last month, President Obama announced a plan to make it a little easier for 1.6 million college graduates to repay their government loans, recognizing the drag that $1 trillion in student debt is placing on the economy.

In the early 1990s, most college students did not need to take out loans. But in 2009-10, 56% of full-time undergraduates at public colleges were borrowers. At private nonprofit schools, 65% had loans. For the first time in our history, student loan debt has exceeded credit card debt. One reason is that over the last 25 years, tuition has risen four times faster than the Consumer Price Index. In California, public universities enacted the highest average tuition increase, 21%, of any state last year, according to the College Board. With states putting up less money to subsidize higher education, more of the cost burden has shifted to students.

The federal government is trying to accommodate the demand, pouring $104 billion into loans last year. At the same time, students are becoming less able to repay. The percentage of borrowers defaulting (and thus ruining their credit) rose 25% last year. High debt loads affect career choices and cause many graduates to defer getting married, buying homes and having children.

Starting with next year’s graduating class, Obama wants to reduce payments to 10% of discretionary income for graduates who apply to the government’s income-based repayment plan. That is an immediate reduction from the 15% that is in effect today. But that only accelerates the phase-in of repayment terms that would have gone into effect in 2014 anyway. Under Obama’s plan, after 20 years of payments, the rest of the loan, if any is still unpaid, would be forgiven. Today, graduates are expected to pay for a maximum of 25 years. The administration also is offering minor changes in repayment terms for those who graduated earlier.

This is welcome. But it doesn’t go far enough. The president should be talking about the effect of student loan debt on the economy as he campaigns for his jobs agenda. Even more important, he should take advantage of the pressure from the Occupy Wall Street protests for relief on this debt and send Congress legislation that offers a much bolder, systemic and long-term solution: income-contingent loan repayment.

Under such a proposal, loans would be offered at a single interest rate for all borrowers; payments would be automatically withheld from the borrowers’ paychecks by their employers and would be managed by the IRS, just as income taxes are collected. As in the president’s proposal, 10% of a borrower’s earnings would go toward their student loans. The more they earn, the faster they would repay their debt. Such a system would not only help graduates manage their student loans, it would save the government money because it would drastically reduce delinquencies and be far easier and less expensive to administer.

Right now when students need to borrow, they and their parents have to navigate a maze of financing options and an alphanumeric soup of loan types, limits and interest rates. Once students graduate, they face an equally baffling range of repayment options that involve various private sector “servicers� such as Sallie Mae. The income-based repayment option that Obama wants to accelerate was a step in the right direction. But it requires borrowers to apply every year and write one or more checks every month. Only 450,000 of 36 million borrowers take advantage of that program.

In contrast, income-contingent loans would be universal and automatic. Everyone who took out a student loan would be put into the program and, because their loans would be tied to their Social Security numbers, the repayments would come out of their paychecks, just as their income, Social Security and Medicaid taxes are withheld.

Australia and Britain have had great success with their income-contingent loan programs. In Britain, more than 98% of loans are repaid.

This idea is not entirely foreign to the United States. Child support payments are routinely withheld by the IRS. Two decades ago Rep. Tom Petri (R-Wis.) remarked in a congressional hearing that an income-contingent loan repayment system would be “far simpler for schools and the government to administer, far simpler for students at application, and more manageable and supremely flexible during repayment, at the same time virtually eliminating the default problem and saving immense amounts of money.�

Back then, the IRS was just moving to electronic processing of tax payments and wasn’t interested in taking on the new challenge of collecting on student loans. Now, however, the technological barriers are gone and, with the large increases in student debt burden, the political climate for reform is ripe.

There is a moral hazard, however. Income-contingent loans could encourage money-hungry colleges to boost tuition even further, so Congress should also provide incentives to colleges to keep costs down. Loans awarded by colleges that didn’t keep tuition hikes within limits could be barred from the income-contingent loan program, which could drive students away.

At a recent congressional hearing, Republicans and Democrats alike expressed great concern over student debt load and default rates. Petri, still a member of the House Education and the Workforce Committee, proposed revisiting his 2-decades-old income-contingent loan idea.

Obama’s proposal is certainly a step in the right direction, but we need Congress to go further. With nearly $1 trillion in student debt on the line, the country can’t afford not to act.

Richard Lee Colvin is executive director of Education Sector, an independent education policy think tank in Washington.