Question about Obama College Loan Proposal

[stephenandrew]

I read the following in the Christian Science Monitor,

"College expenses. In perhaps the biggest move announced ahead of the State of the Union address, the administration is proposing to limit the amount of student loan money that a borrower must repay, to 10% of the borrower's income over and above a basic living allowance."

I had planned to pay for my son and daughter's undergraduate degrees with money I had saved over the years. Son is off to school next year, daughter the following. I had not planned to borrow any moeny, nor ask them to do so. With this new approach to capping student loan repayments, it made me think that maybe I should have them borrow as much money as they could, with the idea being they may not have to pay all of it back. I could use the money set aside for college to help them with repaying the loans.

Does this make make sense?

Thanks.

 

[LOL!]

Your quote is interesting. The idea is that they must repay the loan but at a rate that takes no more than 10% of the borrower's 'excess' income. It is not that only 10% of the loan must be repaid.

I also believe the proposal was to have no more than 20 years of such payments, so that one would not be paying forever.

I cannot see this getting passed.

Also the existing $2500 tax credit for college means that college tuition can go up by $2500 instantly. Colleges know this, so they just raise their prices to capture the tax credit for themselves.

 

[samclem]

A college eduction--the new entitlement.
Your proposed plan (have the kids borrow, you help them make the payments) sounds like it might be the best way to squeeze the gumint money from this program.
But, I don't think the program will pass.
"Easy money" for college is the main reason education costs have climbed much faster than inflation.

 

[FUEGO]

I disagree. I could see this plan passing pretty easily. It would just be a beefed up version of the income based repayment plans that they already have in place.

Direct Loan Repayment Plans

Look under the heading "Income Contingent Repayment". Your payment is 20% of your AGI minus the poverty level for your state of residence and family size. Maximum of 25 years. In other words, the current 20% changes to 10% and the max repayment period changes from 25 years to 20 years. Under the "Income Contingent Repayment" the payment won't exceed what it would have been had you amortized it over 12 years. This is for Direct Lending, but I'm pretty sure my lender had the same or very similar program for my federal student loans.

I'll still have 10-15 years on my student loans when I FIRE. Wonder if I can take advantage of this if it passes? I also thought about enrolling part time in grad school just to get the loans, then dropping out. Rinse, repeat, and do this till you hit the max loan balance allowed ($170,000) for me and DW, then just pay the 10% a year above poverty income. Free money folks, free money.

This may also change my college savings strategy for my daughters. Why save for college if you can borrow a ton of money from the government and not have to pay back a lot of it?

I'd rather be a well-fed fat grasshopper sitting on a beach somewhere tropical than a hard working ant, I mean if the good folks in Washington are footing the bill.

 

[clifp]

I can't imagine why anyone would pay cash for college any more, borrow baby borrow, it worked so well for houses. but a bank can't repossess your diploma

To make matters worse for me and fellow Sallie Mae bond holders (ISM/OSM) the President mentioned during the SOTU that he would eliminating the subsidy for private corporations (like Sallie Mae and banks) for students loans. Although this has been widely anticipated it does make it harder for us bond holder to get paid back.

I don't philosophically disagree with ending the subsidy, but the one thing private corporations bring to the student loan business, is a strong incentive to get people to pay back their loans.Given all of the loopholes and extension available, I don't see government bureaucrats busting their butts to get the taxpayers money back from students.

I had to laugh when Obama called on universities to control the cost, right after announcing the tax credit and more generous student loans. If there is one thing we should have learned from the housing bubble is that easy money increase the price of an asset. You have just given a university across no incentive to control costs and every incentive to raise them. Surely somebody on his economic team pointed that out.

 

[stephenandrew]

So I was thinking about this some more. One of the schools that my son applied to, got into, but was not seriously considering was (in my opinion) a big bucks school. Tuition, room/board, personal expenses, and travel to/from school was projected to be just a hair over $200,000 for 4 years of study. (This assumed no cost increases over the four years, so the number was low.)

For the sake of argument, say my son graduates and gets a the averages $100,000 per year over the 20 years after he graduates. Assuming he has to pay back 10% of his income, that would be $10,000 per year; over 20 years $200,000. Now I know this pretty back of the envelope stuff, but seems to me, borrowing the Feds' money makes a heck of a lot of sense as opposed to using my savings to pay for his school.

Amazing.

 

[queeneev]

My advice would be borrow the student loan, max it out, regardless of the old versus new rules. It sounds backwards, when most finanical advice is around "pay down your debt" and "only buy if you can pay with cash", but student loans are a different animal. Also as an added benny, your student loan debt is forgiven upon death (or at least that was true at one time).

Just as coincidence, I make my last student loan payment this spring. HAHA I am 48 years old and out of school for decades, but I have successfully managed to squeak out a payment plan that has lasted for the better part of my life ! I think my interest rate is like 3.5%.

 

[Bikerdude]

So I was thinking about this some more. One of the schools that my son applied to, got into, but was not seriously considering was (in my opinion) a big bucks school. Tuition, room/board, personal expenses, and travel to/from school was projected to be just a hair over $200,000 for 4 years of study. (This assumed no cost increases over the four years, so the number was low.)

For the sake of argument, say my son graduates and gets a the averages $100,000 per year over the 20 years after he graduates. Assuming he has to pay back 10% of his income, that would be $10,000 per year; over 20 years $200,000. Now I know this pretty back of the envelope stuff, but seems to me, borrowing the Feds' money makes a heck of a lot of sense as opposed to using my savings to pay for his school.

Amazing.

Its even better than that. Its 10% of the difference between his income and the poverty level income. In addition, if he pursues a career in the public sector including police, fire, teacher, state or federal employee, the loan is retired after 10 years. Add that to the benefit to the higher education business....and.....can anyone say..... votes.

 

[FUEGO]

My advice would be borrow the student loan, max it out, regardless of the old versus new rules. It sounds backwards, when most finanical advice is around "pay down your debt" and "only buy if you can pay with cash", but student loans are a different animal. Also as an added benny, your student loan debt is forgiven upon death (or at least that was true at one time).

Yep, DW and I hold $120k worth of this type of "life insurance". Student loans forgiven if the debtor dies. Average interest rate is 1.25% and will drop to 0.75% in a few months. Fully tax deductible above the line. What's not to like??

Thanks Uncle Sam!

 

[FUEGO]

So I was thinking about this some more. One of the schools that my son applied to, got into, but was not seriously considering was (in my opinion) a big bucks school. Tuition, room/board, personal expenses, and travel to/from school was projected to be just a hair over $200,000 for 4 years of study. (This assumed no cost increases over the four years, so the number was low.)

I think the federal student loans are limited to $5500 a year the first year of college and then up to $7500 in the later years of college. Assuming a 4 year period to get a bachelors degree, you would have around $30,000 in loans at the most. Grad school is a little different story with ~$20,000 a year being available to borrow.

 

[plex]

Unless they made it 5% of income, with a 10-year maximum payment period, there is pretty much no way I (or anyone going into a high income field), will end up having any of their loans forgiven, too much income, and it is just about impossible to hit 100k just from stafford loans. I am going to use the income based method until I obtain a job, which results in only unsubsidized/grad+ loans accumulating interest, then pay off all my 6.8% loans within a couple years of working. The 2-3% loans I will stretch out to their maximum payment period of 10 years.

The really big benefit of income based type repayment plans isn't the forgiveness portion of it, it is that subsidized loans stay at 0% until you get a job, no matter how long it takes.

 

[ERD50]

But do the loans still accrue interest? If so, the current ~6.8% loan rates don't make that any great deal.

-ERD50

 

[eridanus]

"Easy money" for college is the main reason education costs have climbed much faster than inflation.

I would say it's because funding for state schools has decreased, putting more of the burden on the students (and their parents, and the government).

 

[samclem]

I would say it's because funding for state schools has decreased, putting more of the burden on the students (and their parents, and the government).

That's a small part of the difference. Costs for public and private schools both skyrocketed, public was just a little more. From Wikipedia:

During the 11-year period charted, both public and private, nonprofit colleges regularly posted tuition increases well above inflation rates. . . . . Over this period, annual, inflation-adjusted tuition increases at public colleges averaged 4.0 percent, while those at private, non-profit colleges averaged 3.5 percent. Cumulative results over this period are average public tuitions growing 53 percent above inflation, and average private, nonprofit tuitions growing 47 percent above inflation.

College inflation started really taking off in 1992 when Stafford loans became available regardless of parental income. More money chasing the same amount of services=higher costs.

 

[eridanus]

That's a small part of the difference.

No, it's a large part of the difference.

Money: College Tuition Keeps Rising - US News and World Report

"The Pennsylvania State University's main campus, for example, received the same state grant this year that it received five years ago, said spokesperson Bill Mahon. So the school raised tuition 5.6 percent this year to cover increased salaries, benefits, energy, and other operating costs, he said."

So the "free money" is declining, and has been for years, which forces public universities to raise tuition.

There's also the "University CPI" and, of course, entitlement.

"Driving college inflation are factors like a 200 percent increase in the prices of scholarly journals over the past 20 years, said David Warren, president of the National Association of Independent Colleges and Universities. In addition, many colleges are feeling pressure from students and parents to upgrade dorms, gyms, and other facilities. Some surveys report that most incoming freshmen, for example, have never shared a bedroom, and are choosing colleges that offer them more expensive single apartments."

The "government is too big" answer as to why tuition is increasing is simplistic, to say the least.

"Finally, many colleges say they are raising tuition to generate more money to hand back to students as financial aid, in part to make up for the federal government's reductions in programs like the Pell grant.

 

[stephenandrew]

I think the federal student loans are limited to $5500 a year the first year of college and then up to $7500 in the later years of college. Assuming a 4 year period to get a bachelors degree, you would have around $30,000 in loans at the most. Grad school is a little different story with ~$20,000 a year being available to borrow.

Thank you for this infromation--I was mistakenly under the impression that one could borrow significantly more than this as an undergraduate. Obviously, this makes it far more likely someone will pay back all of the interest and principal over 10 to 20 years. I guess the second best option is to borrow the money and then pay it back the day my son graduates, since no interest will accrue while he is in school. Kind of like a 0% credit card offer.

 

[LOL!]

But not all loans have that 0% interest accrual while in school, right? One can only get such loans if their EFC (expected family contribution) is less than the COA (cost of attendance).

 

[stephenandrew]

But not all loans have that 0% interest accrual while in school, right? One can only get such loans if their EFC (expected family contribution) is less than the COA (cost of attendance).

Not sure exactly how they determine how much in subsidized loans (e.g. 0% interest while in school) you are elligible for, but what you say makes sense. I guess we will wait and see what (if any) cheap money we are able to get.

 

[samclem]

If the inflation rates at private colleges are only slightly less than those of public colleges and both are much, much higher than the CPI, then it's unlikely that reductions in government underwriting of state colleges explains the majority of the increases.

There's also the "University CPI" and, of course, entitlement.

"Driving college inflation are factors like a 200 percent increase in the prices of scholarly journals over the past 20 years, said David Warren, president of the National Association of Independent Colleges and Universities. In addition, many colleges are feeling pressure from students and parents to upgrade dorms, gyms, and other facilities. Some surveys report that most incoming freshmen, for example, have never shared a bedroom, and are choosing colleges that offer them more expensive single apartments."

Why do scholarly journals increase in price by 200%? Because that's what colleges will pay. Upgrading to single-room apartments instead of multi-occupant dorms, building nicer gyms, etc, etc. These do not sound like institutions that are under tough price pressure from consumers out to get the very best bargain for their dollar. Its sounds like the consumers have a lot of money to spend on this education, and that the schools are upgrading so they can compete for the available students. Where is this money coming from? Look no farther than your local financial aid office and Sallie Mae.

 

[ChrisC]

I don't philosophically disagree with ending the subsidy, but the one thing private corporations bring to the student loan business, is a strong incentive to get people to pay back their loans.Given all of the loopholes and extension available, I don't see government bureaucrats busting their butts to get the taxpayers money back from students.

I had to laugh when Obama called on universities to control the cost, right after announcing the tax credit and more generous student loans. If there is one thing we should have learned from the housing bubble is that easy money increase the price of an asset. You have just given a university across no incentive to control costs and every incentive to raise them. Surely somebody on his economic team pointed that out.

Are you referring to those government bureaucrats who probably contract out most of that work to the private sector anyway, from developing online portals, loan servicing (I bet Sallie has a major contract there) to debt collection? The naked truth about many aspects of government is that the private sector is already running most of these programs anyway.

It's ironic that one would believe the private sector has the incentive and ability to handle student loans, a consumer finance market that the banking industry avoided until the Federal Guaranteed Student Loan (now renamed as the Stafford Loan) program was created in 1965 -- created so that our middle class would have the greater opportunities to attend colleges and universities. The GSL program was virtually a no-brainer for the banking industry (and State Guarantee Agencies funded under the GSL program); the subsidy for in-payment-status loans was incredibly rich for many years (300 basis points above 90 day T-bill rates) and lenders had no incentive to reduce student loan defaults for many years as "bad student GSL paper" was guaranteed by the US Government. Effective collection, if at all, was with the Federal Government, not the private sector through IRS tax refund offsets and closing down many bankruptcy loopholes, after the private sector mishandled most of the debt collection. The GSL program, before the US Department of Education offered a direct student loan component, is a classic case of where the private sector actually lobbied the Government for a program with perverse incentives bestowed on the private sector, which enriched the private sector, and later when the Government attempted to right the perverse incentives and demonstrate that it could finance student loans cheaper and more effectively than the private sector, the private sector/ banking industry then complains about a Government take-over of a program!

BTW, before the GSL program existed, the National Defense Student Loan (later the National Direct Student Loan and now the Perkins Student Loan) program was created as a direct result of Sputnik and our Nation's rush to attain educational and research excellence in 1959. This program was one of the major Federal "campus-based" programs where participating higher educational institutions directly administer loans to students, with the Federal Government subsidizing the interest payments and administration and collection costs. Participating schools fund part of the student loan capital here, essentially creating a revolving student loan fund to finance these loans. My wife and I had one of these 3 percent NDSL loans during college. This program has been around many years and has been quite successful. I believe the government bureaucrats have over the years successfully managed this program.

 

[LOL!]

Why do scholarly journals increase in price by 200%? Because that's what colleges will pay.

The buyers of these journals have disappeared, yet the costs to produce them are the same. So if half the buyers disappear and the publisher wants to stay in business, they need to double the price.

This is just one of the consequences of the Internet age. Few folks go to the library to read journals anymore. Many folks get an electronic subscription that they share with all their colleagues which further reduces the number of real payers. In the end, the libraries are the only legitimate payers and so the price to them goes up astronomically.

And of course many of the journals charge the authors to publish their works.

 

[FUEGO]

I'm not sure how they do it, but my college loan company (a non profit) has competed the pants off the the Direct Loan federal program. We have very high reductions in interest rate for maintaining on time repayment and doing automatic draft. The federal Direct Loan program (at the time at least) did not have the level of interest rate reductions in effect. So the DW who was forced to the Direct Loan program for grad school borrowing ended up consolidating with the local non-profit for the interest rate savings. So the competition is clearly there and has benefited us directly. Maybe the case is that the Direct Loan program could cut some fat and have similar incentives as private lenders.

 

[ChrisC]

I'm not sure how they do it, but my college loan company (a non profit) has competed the pants off the the Direct Loan federal program. We have very high reductions in interest rate for maintaining on time repayment and doing automatic draft. The federal Direct Loan program (at the time at least) did not have the level of interest rate reductions in effect. So the DW who was forced to the Direct Loan program for grad school borrowing ended up consolidating with the local non-profit for the interest rate savings. So the competition is clearly there and has benefited us directly. Maybe the case is that the Direct Loan program could cut some fat and have similar incentives as private lenders.

It could be there are major subsidy incentives given to lenders offering student loan consolidation, which has little to do with private lenders being able to cut fat or provide greater efficiencies. There used to be a so-called Special Allowance Payment that the U.S. Dpeartment of Education would provide to lenders to the extent student loan debt was consolidated. See http://www.gao.gov/new.items/d05389r.pdf. In other words, the Government is probably subsidizing the loan consolidation, in any event.

Student finance on the macro-level, with government credit and grant programs, is a highly complicated area. It's very easy to think of simplistic reasons for how things work in this area.

 

[FUEGO]

It could be there are major subsidy incentives given to lenders offering student loan consolidation, which has little to do with private lenders being able to cut fat or provide greater efficiencies. There used to be a so-called Special Allowance Payment that the U.S. Dpeartment of Education would provide to lenders to the extent student loan debt was consolidated. See http://www.gao.gov/new.items/d05389r.pdf. In other words, the Government is probably subsidizing the loan consolidation, in any event.

Student finance on the macro-level, with government credit and grant programs, is a highly complicated area. It's very easy to think of simplistic reasons for how things work in this area.

Agreed. It's highly complicated. It would not surprise me at all to learn that the feds are paying some subsidy to private student loan organizations that they don't offer through the Direct Lending channel. In our situation, the consolidation loans were available from Direct Lending or the local non-profit with similar (identical??) terms except for the rate decrease feature available at my local non-profit.

As with anything that involves competition, there will be some organizations that innovate and put forth a superior product and other organizations that fail to do so. Sometimes the winner of the competition is state provided (ie our local flagship public universities), sometimes private industry. Sometimes the extent of subsidies causes one competitor or the other to get the upper hand, and these subsidies aren't always visible to the consumer (thinking public universities here again). For me as a consumer, I'm looking for the best quality service or product at the best value.

 

[clifp]

Are you referring to those government bureaucrats who probably contract out most of that work to the private sector anyway, from developing online portals, loan servicing (I bet Sallie has a major contract there) to debt collection? The naked truth about many aspects of government is that the private sector is already running most of these programs anyway.

It's ironic that one would believe the private sector has the incentive and ability to handle student loans, a consumer finance market that the banking industry avoided until the Federal Guaranteed Student Loan (now renamed as the Stafford Loan) program was created in 1965 -- created so that our middle class would have the greater opportunities to attend colleges and universities. The GSL program was virtually a no-brainer for the banking industry (and State Guarantee Agencies funded under the GSL program); the subsidy for in-payment-status loans was incredibly rich for many years (300 basis points above 90 day T-bill rates) and lenders had no incentive to reduce student loan defaults for many years as "bad student GSL paper" was guaranteed by the US Government. Effective collection, if at all, was with the Federal Government, not the private sector through IRS tax refund offsets and closing down many bankruptcy loopholes, after the private sector mishandled most of the debt collection. The GSL program, before the US Department of Education offered a direct student loan component, is a classic case of where the private sector actually lobbied the Government for a program with perverse incentives bestowed on the private sector, which enriched the private sector, and later when the Government attempted to right the perverse incentives and demonstrate that it could finance student loans cheaper and more effectively than the private sector, the private sector/ banking industry then complains about a Government take-over of a program!

Your right the original GSL program was a classic example of the private industry getting a sweetheart deal from the government. It took the government years to finally put incentives in (making vendors eat a few percent of loan losses) for the private lenders like Sallie Mae to actually work to collect loans.

One thing that is worth keeping mind in a discussion on student loans is the reason the private sector isn't in the market, is because it is very risky area for loaning money. For the most part you are loaning money to teenagers or young "adults", who have no work or credit history. There are no assurances that will get a degree, or if they get a degree that it will enable them make enough money to pay back the loan. Even if they do the vast majority of college graduates leave school with a negative net worth. Bankruptcy would be a tempting options (which is why student loans aren't and IMO shouldn't be discharged in bankruptcy) since you can't repossess a diploma. Even with the bankruptcy rule, Sallie Mae and a few banks tried several years ago making student loans without government guarantees and suffered massive losses.

In defense of student loans, I think probably more than any other type of credit there is a large benefit to society to loaning money to college students. We are far better off having 22 year olds with valuable skills like engineering or nursing, that forcing people to save up money and start school in their 30s. Still as many government programs, we have taken worthwhile idea (increasing college graduates) and have gone overboard. Obviously something wrong with a program, where people with the means to pay cash have financial incentive to borrow.

The only reasons I am complaining, is because in time when the skies are raining money from our most generous Uncle Sam and every possible group is getting subsidized, I'm annoyed that one of the few pieces of pork that I benefit is being cut.