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Wednesday, November 28, 2012

Why student loan delinquency rates are rising

Student loan delinquencies rates are up, way up. According to New York Federal Reserve data 90 day delinquencies have risen 2.5 percent to 11 percent since Q1, 2012. These non-payment rates keep rising in to the tens of billions of dollars despite several types of payment plans offered by federal student loan servicers. Among these plans are the income-contingent repayment plan and the income-based repayment plan, both of which reduce the monthly cost of paying back student debt to a manageable amount. So why do grads keep defaulting?  

Complicated applications

As evident in the following payment programs chart, of the three kinds of income linked payment plans, two have to be applied for on an annual basis. Documentation needed includes a tax return, proof of income and an application form. For the borrowers who forget to remember line X, on document Y, written in font Z, that can mean thousands of dollars of extra interest due to a late payment. Even rocket scientists make errors, it would be wise to assume grads will too. 

Insufficient mediation

If a graduate has a complaint against a financial institution that services a Department of Education loan, that loan is mediated by none other than the Department of Education. The potential for conflict of interest is recognizable. The complaint process is further stifled by poor federal disclosure requirements if required at all.  For example, notification of payment plan expiration is not required to be sent by certified mail, and student loan servicers are not necessarily required to prove they even send such notification. 

Negative amortization

The rise in student loan delinquency is also due to negative amortization. This is when the balance of a loan increases, often indefinitely, because the amount of a monthly payment is less than the amount needed to cover the cost of interest. Even though the federal employees, loan officers and others will incessantly repeat the mantra of working with student loan servicers to implement an affordable payment plan, the loan is really not affordable when it is negatively amortizing. Snowballing debt is not a good way to hit the ground running when professional life is only beginning.

Failed investment

Investments that fail lower individual net worth. Naturally, a healthy thing to do would be take the loss and find alternative solutions; in colloquial terminology, suck it up and move on. This is the advice given by some of the same people who would quite possibly consider short selling their home or defaulting on their mortgages because the value of their real estate is less than the amount of the mortgage. Home owners got bailed out to the tune of $22 billion dollars in mortgage relief per Reuters, student loan borrowers have the benefit of no such program.

Federal protection

Federal student loans are usually not subject to typical rules of bankruptcy relief. The Department of Education and their loans are also subject to immunity from the Fair Debt Collection Practices Act. In effect this makes the government above the same law that many Americans attempt to follow. Apparently, the fiscal solvency of the student loan program is jeopardized by loan forgiveness, yet the federal national debt is set to expire in less than two months and has surpassed $16 trillion dollars; an amount in the vicinity of a 1:1 federal debt-to-income ratio.

A problem with student loans is they were originally encouraged via relatively easy availability to fuel the economic need for an educated workforce. That workforce has been experiencing high unemployment and the labor force participation rate had dropped to the lowest level in decades. This means the same need for educated people that federal programs were intended to meet is not there. Even though the promissory notes for these loans were signed under penalty of perjury, there is a flip side to the coin. Namely, a federal intent of educational benefit that's conditions are no longer completely valid.