April 27 (Bloomberg) -- If your child is one of the 1.5 million high school students eagerly awaiting acceptance letters from colleges this month, he or she is probably entertaining dreams of high scholarship, intellectual ferment, new friends, raging keggers.
You probably have a few other things on your mind. For starters, you may be thinking that the average annual cost of a four-year institution now exceeds $20,000. Or that outstanding student-loan debt surpasses $1 trillion. Or that defaults are rising, economic growth is sluggish, and unemployment for those ages 20 to 24 is about 13 percent.
And your little one, bless her heart, wants to major in peace-and-justice studies.
This calculus troubles a lot of parents. Mitt Romney and President Barack Obama spent the past week agreeing that they would like to prevent the federal student-loan interest rate from doubling as scheduled on July 1, but their polarized plans for paying for it -- and the maddening paralysis in Congress -- inspire little confidence. Meanwhile, whispers of a bubble in education loans grow louder.
Easing the Burden
Although we shouldn’t exaggerate the risks of student debt, there are a few steps we can take to ease the burden -- and possibly improve higher education in the process.
Keep in mind that much of that $1 trillion is “good debt.” Most borrowers have manageable loans, and workers with a bachelor’s degree earn 84 percent more over their lifetimes on average than those with only a high school diploma. They also face much lower unemployment rates. So a college loan remains a very smart investment for many people.
But not for everyone. Some students take on more debt than they can expect to repay. Some borrow on ruinous terms. Some drop out, make poor career choices or attend for-profit schools that provide little education. Partly for such reasons, more than 5 million borrowers are past due on a loan account.
So the first step should be increasing transparency in a dreadfully complicated market. According to NERA Economic Consulting, about two-thirds of private-loan borrowers don’t understand the differences between federal loans (fixed interest rates, income-based repayment options, robust consumer protections) and private ones (variable and sometimes usurious rates, inscrutable terminology, few borrower protections).
That’s symptomatic of a larger problem: Many high school students have a poor understanding of how the loan system works, what help they’re eligible for and how much they’ll eventually owe.
Legislation recently introduced in the Senate, the Know Before You Owe Act, would require private lenders to confirm that borrowers are enrolled, give them regular updates on their loans and their accruing interest, and report annually to the Consumer Financial Protection Bureau. It would require colleges to counsel students about their aid options and their rights as borrowers. Similar transparency should be demanded of schools offering financial-aid packages and of debt-collection companies: Documentation should be clear and standardized throughout the process.
The second crucial step is to mitigate the burdens of already distressed borrowers. The Obama administration has made progress, for instance by proposing an initiative that would let some students limit their loan repayments to 10 percent of their discretionary incomes next year and would forgive balances after two decades. Private lenders should be given incentives to offer more modifications and flexible payment options.
Finally, moving toward a more widespread income-based repayment model, in which debtors pay more as their salaries increase, would make economic sense and could help rationalize the student-loan system.
This could be done partly through the bankruptcy code. Student debt is generally nondischargeable in bankruptcy. This helps assure lenders that if they take a risk in giving a loan to someone with no immediate earning power or collateral, the borrower won’t declare bankruptcy to clear his debt after graduating. But it also has a distorting effect: Lenders are encouraged to take credit risks -- for example, by extending loans to students who attend an expensive school with a low job-placement rate.
Tying dischargeability to the average salary of graduates of a given school could offer a useful corrective. For instance, loan payments in excess of 10 percent of the average annual salary of an institution’s graduates could be discharged in bankruptcy. This way, lenders would start to avoid schools that aren’t increasing students’ earning power. Such a market solution could help weed out fraudulent schools, and it could push students away from expensive institutions that underdeliver educationally and toward schools that offer more value.
Loans with co-signers or those on which parents borrow for their children against current assets or income should also be dischargeable.
More controversially, a “progressive discharge” system tied to the average salary of specific career fields might encourage lenders to tighten their standards and take into account what borrowers plan to study. This could have drawbacks, such as discouraging students from following their intellectual passions or from going into socially valuable but relatively low-paying work. But it’s worth considering: If structured right, it could better align student majors with the demands of the modern workplace.
Ultimately, all these changes -- while helpful in the short term -- would only be first steps. As college costs continue to soar, and taxpayers continue to foot more of the bill, we’ll need to consider more far-ranging reforms. Should we move toward expanding the government’s income-based repayment system, or start reducing the federal role altogether? Perhaps move away from the debt-financing model and toward an equity-financing model, in which schools would get a fixed percentage of students’ future earnings? Invest in overhauling the classroom for the digital age? These will be questions for the next generation of college applicants.
For now, kids, enjoy your time in school. It will only get harder from here.
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