The American Student Debt Crisis: Why We Should Worry

Published in the Horace Mann Review, November 2019

“An investment in knowledge pays the best interest.” So said Benjamin Franklin in his 1758 publication offering financial advice, The Way to Wealth. However, in 2019, it seems that the only entities receiving interest from student educational investments are the federal government, private lenders, and loan service providers. The United States’ 44 million student borrowers have a combined debt of a staggering $1.5 trillion, with approximately one third of all American adults aged 25 to 34 having student debt. The root cause of the problem is simple: the cost of college has been rapidly increasing since the 1980’s, with the cost today being almost double its cost four decades ago. Instead of seeking higher education and providing themselves with financial stability, students have found themselves acquiring the opposite: a large and long term financial burden.

Crushing debt is not only extremely stressful for the American student population, but it could also be slowly degrading American living standards. Some speculate that the student loan burden is preventing first-time job seekers from homeownership, while others point out that the debt is driving students away from public service jobs towards higher paid occupations without a social purpose. Moreover, students from middle income households are unable to opt for jobs that require post-graduate qualifications, such as law or medicine, and instead are forced to take up any job that will give them some immediate income to pay back their loan and for day to day sustenance. The American student debt crisis is causing a slow degeneration of the next generation’s lifestyle and dreams. To advocate for a proper set of policy solutions to the crisis, one must deeply analyze the root of the issue.

The loan repayment process itself is a hodge-podge that drives students down dangerous debt rabbit holes. In order to reduce debt for future borrowers, the process has to be simplified to prevent students from being beguiled into the wrong plan. Roughly 90% of student borrowers take out loans from the federal government; the government then outsources the management of these loans to private loan servicers. When paying off their debt, borrowers are offered various repayment plans. The loan repayment plan becomes especially significant when students are struggling to make payments on time. Because student loans have compound interest, the loan can grow very quickly when large amounts of interest go unpaid. The standard federal repayment plan requires that students pay an annuity, which is a fixed monthly payment. When borrowers are unable to make their monthly payments, they are usually faced with two options: the forbearance plan and variations of an income-based plan. Loan servicers like Navient have in the past driven borrowers into the trap of forbearance. Students forbear their loans when they decide to postpone their payment for a set period of time. However, when they resume repayment, their interest payment skyrockets because of the backended principal repayment. This forbearance trap often makes the loan repayment process even more unaffordable and leaves students with less savings than under the standard repayment plan. The alternative would be an income-based option, which is often a graduated and extended version of the standard repayment plan that ties repayment to the borrower’s income. This plan charges monthly debt service by capping the payment at a certain percentage of one’s disposable income and thus the interest payment increases gradually with increasing income. The income-based plan gives students breathing room because it usually leaves them with more annual savings, due to the gradual increase in interest debt service rather than high initial payments. Moreover, such a plan gives students more time to repay their loans. However, in order to make a quick buck off of student borrowers, loan servicers quite often dupe them into forbearing their loans, leaving students with fewer annual savings and with risky debt service payments.

The fact that young people are saving less of their income is not the only problem caused by accrued student debt. Unlike previous generations, young Americans are also being deprived of equal opportunity to succeed. Due to the fact that students are invested in repaying their debt, many of them are turning away from homeownership. This is an indicator that spending in the property market is in decline, which is a dark sign for the consumption-driven American economy. The slump in spending by millennials is not limited to homeownership: there is also a slowdown in entrepreneurial ventures by young adults. Young people are more likely to dedicate their dollars towards paying off their debt rather than taking the risk of starting a business. As a result, the number of young people who start companies is in steady decline. In 1996, 35% of startups were created by young people; as of 2014, that number plummeted to 18%. Student debt has also hindered young Americans’ job choices.Students who want to study law or medicine after undergraduate qualifications cannot afford to take more loans and are forced to take up jobs that they don’t care for. Not only is society missing out on numerous potential public servants, lawyers, doctors, or entrepreneurs, but young people themselves are not feeling fulfilled in their respective jobs. By refusing to implement policies that rescue young people from this cycle of debt, the government is failing the next generation.

There is no quick-fix for any problem of this scale. However, it is possible to judge the merits of a host of proposals that have been pitched to solve different aspects of the student debt crisis. Many young people are being misled by their loan servicer and, due to the immense complexity of the system, students are forced to make poor short-term decisions when choosing their loan repayment plan. As a result, almost 30% of student borrowers default on their federal loans within 12 years of graduation. Some policy think tanks argue that making income-based repayment plans universal and automatic would dramatically reduce the size of individual loans. The current federal income-based plan, Revised Pay as You Earn (REPAYE), allows borrowers to pay 10% of their discretionary income for a 20 year maturity, leaving the remaining loan balance forgiven. By making REPAYE the default repayment plan, students would not be at risk of defaulting because the plan is tailored to match their income. The plan would also prevent loan servicers from driving students towards risky plans such as loan forbearance. Universal REPAYE would improve credit scores for young borrowers, which have been blemished by delinquency on student loans.

Another way to reduce the debt burden of student borrowers is by changing the system of repayment. Some center-right economists argue that the reason college costs are not decreasing is because of the unlimited student loans offered by the federal government. They’re partially right. The student loan system needs to be steered away from middlemen such as private lenders or the federal government to simplify the loan process and incentivize colleges to cut costs. Private colleges could create tuition deferral programs, which would allow colleges to give the loans themselves, making them invested in students’ futures. Under this design, private colleges would allow students to defer up to 75% of their entire college costs, and repay them over a 20 year period post-graduation. This system would not only cut out the lending middleman, but it would also ensure that colleges feel compelled to prepare students adequately for the job market because the repayment of their tuition depends on the student’s future income. Colleges would also be able to offer students lower interest rates than the government or private lending rate; it is less risky for colleges to offer loans than the federal government, since colleges have physical assets and a guarantee of tuition revenue from future students. To incentivize private colleges to adopt this payment system, the government could propose to revoke the tax-exempt status of private colleges if they don’t offer tuition deferment programs; after all, if the institution is only concerned about short term revenue, then it shouldn’t be considered a charitable non-profit organization.

Finally, college costs must be brought down to alleviate the student debt crisis. Students only take out loans because college is unaffordable for them. No student should have to borrow to cover the cost of higher education. In 2019, Senator Bernie Sanders reintroduced the College for All Act to make public four year colleges tuition-free for all Americans. The bill would make a significant difference in reducing college costs across the board, and would eliminate the need for any student to take out a loan. This is not a utopian idea; several European countries, most notably Germany, already have robust tuition-free college schemes. This is also not as expensive a proposal as some believe; free public college is projected to cost about $79 billion a year. In 2016, the federal government spent $91 billion on subsidizing college attendance. A portion of that expenditure, coupled with a more progressive tax code, could fund free public college in America.

The student loan crisis is already damaging the lives of so many students, and is on track to harm the wider American economy. By universalizing income-based repayment, by encouraging colleges to defer tuition, and by making public college tuition free for all, future generations can be rescued from the life-crushing load of student debt. It is crucial that this crisis is tackled before the repercussions at a micro level are reflected in the macro economy.