Student Loans: No Credit? No Collateral? No Problem!
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
Last week, the Wall Street Journal published an article on rising student loan default and delinquency rates on the same day Ryan McMaken posted about rising tuition and fees at universities across the country.
The statistics are harrowing. Per the Education Department and the New York Fed, 43 percent of federal student loans are in postponement, delinquency, or default. And, while credit card and mortgage debt have fallen since the peak of the housing boom, student and auto loans have soared.
Student loan delinquency rates have surpassed the 2010 peak mortgage delinquency rate of the housing bubble and credit card delinquency in 2012.
The reason for this is that lending standards for federal student loans have deteriorated, down to one criterion it seems: the ability to sign your name. Finaid.org confirms that “Stafford, Perkins and PLUS loans do not depend on your credit score.” Only PLUS loans are dependent on credit history at all, with the requirement that parent borrowers do not have adverse credit history.
Of course, all of this is reminiscent of a ballooning housing bubble. Instead of climbing home prices, we have climbing tuition. Instead of declining lending standards for home loans, we have the same for student loans. Instead of mountains of mortgage debt, we have an ever increasing amount of student debt. A cultural mandate that everyone deserves to go, should go or has a “right” to go to college has replaced a similar mandate about home ownership.
The biggest difference, however, is that there is no collateral for student loans. With mortgages in default, the lender can at least recover the house that served as collateral for the loan. The WSJ article reveals that some borrowers are using this fact to their advantage in choosing which bills to pay first:
Some borrowers aren’t repaying even when they can. Research from Navient shows that borrowers prioritize other bills — such as car loans, mortgages and heating bills — over student debt. A borrower who fails to pay down an auto loan might have her car repossessed; with student loans, there is no such threat.
Another difference is that student loans cannot be discharged after bankruptcy. Even after default, the borrower is still on the line for the amount borrowed plus interest and other fees.
Some schools, like Purdue University, are trying income-based tuition payment, where students are funded today in exchange for a future cut from their post-school income. The New York Times reported on this new trend:
A senior studying mechanical engineering, one of Purdue’s most popular majors, could get $15,000 in return for a commitment to pay 4.23 percent of his or her income for a bit less than eight years. Purdue estimates that the engineer would have a starting salary of about $56,000, and will be making monthly payments of $200. In that hypothetical situation, the student would eventually repay a total of $20,647.
But an English major can anticipate a starting salary of $34,000, by Purdue’s calculation. For that student, the school would offer a different package, which might require a higher percentage of income over a longer period.
Indeed, such a set up gets closer to aligning the preferences of the borrowers and lenders in a responsible way. The lenders in this case have an incentive to lend to student borrowers who have a high probability of earning an income that can fully pay back what was borrowed. Many small firms are breaking away from the current student loan paradigm, realizing that probability of repayment is important in any loan contract.
You can bet that however this education bubble pops, abstractions like “greed” and “profit motive” will be blamed. They might get attached to profligate universities or private lenders, but no blame will ever reach the real culprit (and owner of most student loan debt): the federal government.
Jonathan Newman is Assistant Professor of Economics and Finance at Bryan College and an Associated Scholar of the Mises Institute. He earned his PhD at Auburn University while a Research Fellow at the Mises Institute.