Student Loan Forgiveness Plans Could Be A Victim Of Their Own Success

Student loan debt in the U.S. currently totals more than $1 trillion, with some predicting it will only get worse as tuition increases continue to outpace inflation. Recently launched federal student loan forgiveness programs were intended to provide relief to some of these borrowers, but the plans’ unexpected popularity has created a new set of concerns.

With tuition costs rising by an average of 6% each year over the last decade and students graduating with an average of $29,000 in student loan debt, which can prevent consumers from making big purchases in the future, it’s no wonder students and the government are looking for ways to alleviate the burden.

In recent years, plans have taken shape aiming to help students pay back their federal student loans. However, the debt forgiven by the government is adding up more quickly than the feds anticipated; one program is expected to reach $14 billion next year, exceeding government expectations by 90%, the Wall Street Journal reports.

That program, known as Pay As You Earn, allows borrowers to pay 10% a year of their discretionary income in monthly installments. The unpaid balances for consumers working in the public sector or for nonprofits are then forgiven after 10 years and those working in the private sector after 20 years.

Supporters say the plan is working as it was designed and that it teaches students responsibility while allowing them to pursue careers in fields that are historically low-paying.

One such benefactor is Jacqueline, a 2012 graduate from Syracuse University, who now works as a public defender in New York. By using the income-based repayment plan, Jacqueline pays about $350 per month toward her $180,000 in debt. With a salary of $58,500, she tells the WSJ that without the plan she would not be able to continue working in the public sector.

While the popularity of the program is obvious in the quickly growing tab for forgiveness, government officials and researchers are voicing concerns that students and colleges could exploit the plans.

Senator Lamar Alexander of Tennessee can see the benefit of the program but tells the WSJ that he supports the proposed changes.

“Income-based repayment can be a way for students responsibly to manage debt, but it should not be a bailout for students who borrow too much or for schools who charge too much,” Alexander says.

A report [PDF] by the Brookings Institute, “Student Loan Safety Nets: Estimating the Costs and Benefits of Income-Based Repayment”, found that the existing program may be four times more costly than it needs to be in order to protect borrowers.

“Not only is loan forgiveness unnecessary for ensuring that monthly payments are affordable for borrowers, loan forgiveness creates incentives for students to borrow too much to attend college, potentially contributing to rising college prices for everyone,” the report states.

In fact, one of the most worrisome aspects of the forgiveness plan, as detailed in the Bookings Institute report, is that students will act more recklessly toward their borrowing if they know someone else will eventually foot the bill.

A common worry about any insurance-like program is moral hazard, where the insured engage in more risky behavior because they don’t have to bear the full cost of their actions. In the case of income-based repayment programs, the moral hazard is that students take on more loans than they otherwise would because they know they won’t have to pay the full cost if they experience low incomes later on.

To address the possible risky behavior brought on by the program, the report authors suggest eliminating the forgiveness program altogether. However, to still provide incentive for students hoping to working in the public sector, they suggest providing direct benefits, such as tax credits, to all workers instead of those who just borrowed to pay for college.

While doing away with the program doesn’t seem to be in the cards just yet, the government is poised to make changes. To stifle the growing tab, the administration is proposing a cap for debt eligible for forgiveness of $57,500 per student and extending the forgiveness window to 25 years.

The Wall Street Journal reports that it is unlikely Congress will pass any of the changes this year, but that the proposals are meant to ensure the “neediest borrowers” continue to benefit from the program.

Still, some opponents of the plans suggest there are other options or programs that could help solve the overarching problems of the trillion dollars in outstanding loans currently held by students and the rising costs of college.

Tim Donovan with Salon suggests that the government enact a “comprehensive program of loan forgiveness.”

“For millions of Americans who’ve already finished school and are still struggling with debt, the [forgiveness program] simply doesn’t do enough — for some, it’s unavailable, and for others, it’s a trap, keeping them in a well of poverty where higher wages only translates to more money for Uncle Sam. We need an unconditional loan forgiveness program for the most desperate Americans, whose degrees are an ornament and whose debts are a weight.”

Additionally, to take on the root of the problem – the rising cost of tuition – there should be some form of public higher education for free. By offering some level of free college, Donovan contends that private, nonprofit schools would be forced to price tuition competitively.

A variation of that solution is already in the works in two states. Earlier this month, the Tennessee House of Representatives and Senate gave their stamp of approval on a plan that gives all Tennessee high school graduates the opportunity to receive two years of free tuition to community colleges or technical schools in the state

The Tennessee Promise, which will be funded by $300 million from the state’s lottery fund, will take effect in fall 2015. The state expects more than 25,000 students to apply for the estimated $34 million earmarked for the first year of the program.

The city of Kalamazoo, MI, has taken care of their college seeking graduates since 2005 with the Kalamazoo Promise. The program aims to pay the tuition for most students who graduate from the district’s high schools and wish to attend any of Michigan’s public universities or community colleges.

While the programs in Tennessee and Michigan are promising first steps, the authors of the Brookings Institute report maintain that forgiveness programs are helpful in enticing prospective students to follow their dreams, but changes need to occur of the plans to withstand future generations.

Student-Debt Forgiveness Plans Skyrocket, Raising Fears Over Costs, Higher Tuition [The Wall Street Journal]

Millennials are just this screwed: Banks and colleges win, debt-ridden graduates left to suffer [Salon]

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