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Issue Brief: What to Do Now to Help Student Loan Borrowers

More and more, students and their families are turning to loans to finance higher education.  This comes as no surprise, given that the cost of tuition has increased five-fold since 1985.  As a result, student loan debt now exceeds credit card debt, topping $1 trillion outstanding.  According to recent estimates, student loan borrowers hold over $25,000 on average in student loan debt.

Congress should act now to ensure that borrowers are better informed before they sign on the dotted line, and have meaningful options for managing their debts in repayment.

The Problems

The problems with the student loan market occur at the front end, when students sign up for the loans, and at the back end, when the debts are required to be repaid.

At the front end, students and their families often receive inadequate information and counseling about their options for financing college.  Financial aid letters are not standardized which makes it difficult for students to compare financial aid offerings from different schools, and some schools fail to distinguish between loans and true “financial aid” such as scholarships.  Many borrowers do not understand the terms of their loans, and end up surprised about the size of their monthly payments after graduation.  It is also common for student loan borrowers to take out unnecessary private loans without knowing that they may be eligible for federal aid.

At the back end, student loan borrowers may face problems with repayment.  For example, borrowers with federal loans may receive inadequate information about flexible repayment plans and deferment or forbearance options.  The income-based repayment (IBR) plan, for example, ties monthly payments to a modest percentage of the borrower’s adjusted gross income.  However, borrowers must affirmatively request this option before they start repaying the loans.  Otherwise, they are placed into a standard 10-year repayment plan. If the monthly payments are too high, borrowers may default unless they affirmatively request a deferment or forbearance that temporarily suspends their payments.   Even if the borrower completes the required number of payments under IBR and becomes eligible to have the remaining balance forgiven, that forgiven amount may be treated as taxable income by the IRS.

Borrowers with private loans have limited rights.  They do not have a guaranteed right to receive flexible repayment options, or to temporarily suspend their payments through a deferment or forbearance.  Private loans can come with high variable interest rates, making them even more difficult to repay in times of unemployment or underemployment.

Borrowers who default may be subject to aggressive collection tactics for years.  There is no statute of limitations on federal student loans, so borrowers can be pursued to the grave.  The federal government can garnish wages and even benefits like Social Security from borrowers in default without having to sue in court.  Meanwhile, both federal and private student loans are nearly impossible to discharge in bankruptcy, unlike other types of unsecured debt such as credit cards.

What Has Been Done

In 2007, Congress passed the College Cost Reduction and Access Act (CCRAA) with bipartisan support.  It reduced interest rates on some federal loans, created the IBR program, and created a loan forgiveness program for graduates committed to public service.  In addition, as part of the 2010 Dodd-Frank Act, the new Consumer Financial Protection Bureau (CFPB) was given jurisdiction over private student loans – an industry that has been lightly regulated till now.  The CFPB is working with the Department of Education to create model disclosures that clearly explain borrowers’ various financing options and estimate their average monthly loan payments after graduation. 

What Needs to Be Done    

Students and families need better information about their options before agreeing to take out student loans, and borrowers struggling to repay their debts need reasonable safeguards to help manage their obligations responsibly.  Congress should enact the following reforms now to bring relief to student loan borrowers:

  •  Maintain the current 3.4% interest rate on subsidized Stafford loans.  This rate is set to double in July 2012 to 6.8% – an increase that will soon affect almost 8 million borrowers on new loans in the upcoming academic year. 
  •  Increase funding for work-study programs, to help students pay for tuition by working in school.
  •  Require private lenders to get school certification before students can obtain private student loans.  This would give schools the opportunity to inform and counsel students about any eligibility for federal aid.
  •  Require standardized financial aid award letters with common definitions, to ensure that students and families understand their grant, scholarship, work-study and loan options. 
  •  Expand access to flexible repayment plans and deferment options for private loan borrowers and borrowers struggling to stay out of (or get out of) default.
  •  Restore bankruptcy rights for student loan borrowers, especially for private loans.   Private loans are no safer than credit cards for financing education, yet credit card debts can be discharged in bankruptcy while private student loans cannot.
  •  Restore a reasonable statute of limitations on federal loans.  It is hurtful to borrowers and to our economy to keep older Americans – even seniors living off Social Security – on the hook for student loans to the grave.
  •  Set reasonable time limits on repayment periods, and exempt forgiven debts from taxation.  Student loan borrowers should not be subject to decades-long repayment periods or stuck with a hefty tax bill after qualifying for forgiveness.