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The Problem with Senator Warren’s Student Loan Bill

Senator Warren’s bill failed to gain enough support to move on from the Senate. Now that it’s dead, let me tell you why I’m glad for that.

This bill is a bad idea. It does little to help already struggling borrowers, and hurts more than most folks realize. Further, with President Obama’s recent executive action last week, this bill does even less than before the announcement.

What was the Bill about?

The bill’s main focus was refinance.  It would have allowed federal loans to be refinanced at lower rates.  You can get details in my past blog about the bill.  Not all folks would have received a lower interest rate, which means there are a fair number of folks who gain nothing.  Another interesting piece of the bill would have allowed private student loans to be refinanced into federal loans.  The benefit would have been lower interest rates and affordable repayment plans.  However, the bill was doomed from the start because of the way the bill financed the refinances – tax on the wealthy.  This is such a hot button that there was no way this bill was going anywhere.  That’s not my political view, it’s a political fact.

Problems

The obvious problem is that this bill does not address or even hint at the root of the problem, the loans themselves – why are they needed.  This bill MIGHT make loans more affordable, but there are programs out there already, which significantly weakens the interest rate affordability argument.

Undergraduate Federal Loans

Undergraduate Stafford loans are capped for each year of attendance.  A four-year graduate can have, at most, $27,000 in Stafford loans.  Even at the highest interest rate of 8.25%, over 10 years the payment would be $332.  Over the past few years, the interest rate was under 4%, creating a payment of $273.  That’s a car payment for most folks.  Undergraduate loans are not the problem, you’ll see why in a minute.

Graduate Federal Loans

Graduate Stafford loans are capped at $20,500 per year!  In addition, graduates can have uncapped graduate PLUS loans.  It is easy to see how graduates have loan balances of $50,000, $100,000, even $250,000 in just federal loans.  If we low ball this and look at a borrower with a balance of $80,000 (remember $27,000 is from undergrad) and assume a low 4% interest rate, the 10-year payment is a whopping $810 a month.  This borrower could stretch the term out to 25-years, dropping their monthly payment to $422.  Unfortunately, there are quite a number of borrowers who can’t afford this.

Income Driven Repayment

Enter income driven repayment.  Here, the balance of the loan is not a factor; only the borrower’s income and family size matters.  Take a fresh undergraduate Graduate.  Their first job may well be in the fabulous world of retail (I did it, no shame there!) with an amazing pay of $10 per hour!  That’s $400 a week or $20,800 gross per year.  Thanks to income driven repayment, this borrower’s payment is only $41 a month.  Do we care about interest?  NO, because if the loan isn’t repaid in 25-years (it could happen with today’s economy), the balance is forgiven.

Consider the graduate Grad with $80,000 in loans.  Assume a family income of $65,000 and a family of 4, the income driven repayment is $365, less than the 25-year term repayment.  Again we don’t care about interest, the loan is forgiven if not fully paid in 25-years.

Obama’s Plan

Obama’s plan weakens Senator Warrent’s bill even more because it takes income driven repayment and makes it even more affordable.  The borrower who was paying $41 would pay only $27 under Obama’s plan.  And the other borrower paying $365 pays only $244 with Obama’s plan.  Interest?  Who cares!  The government writes it off!  Didn’t Senator Warren say the Government shouldn’t be profiting from student loan borrowers?  It can’t with the income driven repayments.  Before you get all conservative, think what this does for the economy.  More money in pocket means increased GDP.  Houses, cars, large consumer goods would start moving again.

The Unseen Problem

The largest problem I have with Senator Warren’s bill is the debt swap – refinancing private student loans.  This is yet another bank bail out, something Senator Warren never supported.  But that is exactly what this clause is.  And here is the biggest danger of this.  Allowing private loans to become federal loans takes the pressure off of the movement to allow private student loans to be discharged in bankruptcy, as they were before the 2005 bankruptcy code  changes.  I don’t like that.  Worse, the debt swap would only be allowed for a limited time.  After that, new folks will be stuck with private loans and all the negative consequences.  No, don’t use fed money for a bail out (band-aid).  Allow bankruptcy and let the creditors suffer for refusing to work with borrowers and extending credit when it shouldn’t have been.  Obviously lenders haven’t learned a thing from the mortgage crisis.

Real Change

I know people will have an issue with this.  They’ll want to know why I don’t support federal loans also being allowed discharge in bankruptcy.  Truth is, I do support it, but I also know it takes baby-steps to make change.  The easiest change to get done, right now, is allow private student loans to be discharged again.  It doesn’t cost tax money, why protect private banks?  Once we get that change, we can work on more.

Want other changes, like making college affordable?  To do that, we need to understand why college costs so much in the first place.  That’s for another blog.  Bottom line, if you want to fix the system, you have to fix the folks that can make the changes – Congress.  It’s election time folks, time to make a difference.

 

Comments

  1. Tara

    I have to wonder if the law will ever change on private student loan bankruptcy. I am one of many students who have defaulted loans due to unforeseen circumstances. I tried to work with the servicer, but all I got was pay or else. Now years later I have been hit with lawsuits and I am worried about the future.

    • Joshua Cohen

      I believe private loans will be allowed bankruptcy discharge again. You should contact your Congressional representatives to make sure they support Senator Durbin and Representative Cohen – they each have a bill related to this.

      • Tara

        Have you handled cases involving National Collegiate Trust before? I have hired an attorney to defend my lawsuit as they were not the original lender, but there are not any attorneys in my area who specialize in student loan lawsuits. I am wondering what we need to do to have the best shot at beating these lawsuits.

  2. Attorney Brian Fleming

    Josh,

    Maybe I am under a false impression here, but I could have sworn that when income based repayment plan balances are “forgiven,” presumably after the applicable repayment period has been fulfilled by the borrower, that a discharge of indebtedness income tax is levied by the IRS, provided the servicer files a 1099 (I think that’s the correct form). If that is true, then the interest rate DOES MATTER, and in a significant way. Consider my situation. I owe $200,000 now to the federal student loan servicer because I went to law school. $50,000 of that balance is interest alone, and I didn’t even take out a loan until late in 2008. I am now on the pay as you earn income based repayment plan, the best one possible. Every month, I don’t even come close to paying the interest that accrues. After another 18 or 19 years of that, my principal balance, with all the added unpaid interest, will be staggering, like maybe as much as $400,000 or more. If the IRS considers that income, I’m looking at an absurd tax hit, maybe upwards of $150,000, due immediately, and to the unforgiving IRS, who don’t have the type of friendly repayment plans that are allowed with federal student loans.

    This is a major problem. Unless Congress amends the statutes that govern these income based repayment plans, there will be catastrophic consequences for borrowers.

    What are your thoughts on that?

    Sincerely,

    Brian Fleming (former bankruptcy attorney)

    • Joshua Cohen

      My thoughts are you should run the numbers. The interest rate fix is not that sizable for your class. In fact, and I might be wrong because I’m not going to research it for this response, I believe your interest rates are better than what the bill proposes – which would mean the bill doesn’t do squat for you. You should also realize that the PAYE plan is actually what makes it worse for you. With IBR, you’d be paying a larger part of interest which means there would be less forgiveness. But PAYE is more affordable. Which do you want – easier survival now or easier consequence at the end? You’re also forgetting things about the tax consequence. It is possible for many folks that in 20/25 years they will be insolvent. It is possible Congress will make the forgiveness non-taxable. There is also a legal argument that only the principal is taxable since you gained no benefit from the accrued interest. Lastly, the tax is dischargable in bankruptcy. To me, the interest is still a red-herring that does little good. Yes, some will benefit, I think most won’t.

    • Laura

      I share your concern about the tax consequences of loan forgiveness. I think it would be disastrous for me too since I am on an income sensitive repayment plan for my federal student loans (and they’re still $400 a month since I owe roughly $175,000) and I’m sure when and if I ever get the loans forgiven after 25 years, I will get hit with an outrageous tax bill. I had some credit card debt forgiven a few years ago and was taxed about $2,000 on the forgiveness. I had to take out a loan to borrow for this to pay the IRS! It was awful. One can enter payment plans with IRS for upaid taxes but no thanks, I would rather owe another agency than the IRS itself.

      • Joshua Cohen

        I think the IRS is easier to deal with than ED. Remember, taxes can be discharged in bankruptcy – if the circumstances are correct. Compare that the Federal loan bankruptcy discharge. I’ll take the taxes thank you.

  3. Alice Clark

    What would you think about a new effort to make federal student loans no or very low interest? A candidate for a Congressional primary in my district, a bright state representative who ended up coming in 2nd, made that part of his campaign platform. This has caused me to rethink my pessimistic attitude that this would never happen, given that this huge profit off of ridiculously high interest funds the entire student loan program and more, which the feds are very tight lipped about.

    However, I think that the mood of the country really changing as people all across the political spectrum have begun to grasp that financing our education has been unaffordable for so many and is getting worse. Sure, colleges themselves have to reign it in, but the public will demand that Congress “do something.”

    • Joshua Cohen

      I would support that, but remember that Senator Warren proposed that – 0.75% APR for student loans, it’s what the banks get! I think capping federal loans would be a good start. Undergrads can only get $27k with 4-years of Staffords. Graduates can get $20,500 per year – that’s $41k for an MBA, $61,500 for a JD, and potentially $102,500 for a PhD. Add uncapped graduate PLUS loans, and you see where this is going. Cap Grad PLUS loans and thinks might get interesting.
      I also think a lot of this problem would go away if the Dept of ED would properly advertise income based repayment. Less folks in default means better credit and potentially more money available for consumer spending. I’m not an economist – but I’m talking to a few.

      • Reed P. Wyatt

        Dear Sir,
        Your suggestion that we should cap GradPlus loans frightens me greatly. Do yo have any idea what that could do to DBA students like myself, who have been unable to graduate on time for one reason or another? If you set the cap too low, you run the risk of forcing people out of school before graduation. They would then have crushing debt and no degree to provide them with the opportunity for a better job. That also would be a bad situation. Also, what about people who need a second graduate degree for whatever reason. All in all, I think caps are a case of throwing the baby out with the bath water. Thank You, Sir.

  4. Bob

    The lowest interest rates available on grad school loans is 6.8%. If it were 4%, this would be a non-issue. 6.8% (or more) is just too damn high!

    • Joshua Cohen

      Then my example is even more on point. Even at 4% it’s not affordable!

  5. Cyrus

    I think you simplified the issue to only those that qualify for income based repayment and are willing to pay loans off in 25 years.

    My wife and I are high wage earners that are paying our loans off in the typical 10 years. However, our 8.5% interest rates (or in some cases, variable interest rates) cannot be refinanced or consolidated. Therefore, we are making additional payments on each to try to reduce the principal and avoid some of the interest charges.

    While I am thrilled to see current low interest rates for students, we went to graduate school in the window between my boss (under 3% interest rates) and the current low interest rates, so we are forced to pay the 6.8% (my lowest rate) to 8.5% (my highest rate) interest rates that definitely profit off of us compared to easily obtainable credit.

    I know it is a “good problem to have” to be able to afford $2,000 a month student loan payments, but I just lost my job and even when I find a new one, this directly affects my disposable income and my ability to help put fresh money in the economy– it is all going to whoever profits from student loans.

    • Joshua Cohen

      Point taken. This bill would help you refi and drop your interest by 2%. That could help.

  6. Attorney Brian Fleming

    Thanks, Josh, for your comments regarding my situation. I think that when you consider that the income based repayment plans are relatively new, that the discharge of indebtedness income tax hit possibility hasn’t occurred yet most people if anyone in these income based repayment plans. When those “chickens come home to roost” so to speak, I think Congress will be forced to look at the issue and possibly make the forgiveness a non taxable event. It really defeats the purpose of these IB plans if one is looking at a significant tax hit immediately following the successful completion of a two decade plus repayment plan. The argument that only principal should be taxed, as opposed to interest, is certainly an interesting one. I really wouldn’t care as much about that tax hit, especially knowing that I can discharge that tax debt in bankruptcy (I believe after three years of delinquency or default).

    • Kris the PhD Student

      THANK YOU, Brian, for finally saying what I have been trying to tell everyone about my own situation. Having only about $15k in college loans after graduating, most of my loans came from attending GW- that got me up to $102k total. I am now a funded PhD student (so hoping, by the end of it all, I’ll have a PhD and no more than $180k of debt!), and realized that, WHILE a full time student, my loans will still be accruing $450/mo in INTEREST ALONE even if I take out no further loans for the course of my 5-6 year PhD program. All while I am a full time student. Of course, I knew whatever I’d taken out, I would need to pay back. Did I know I would be required to pay $450 per month just in interest WHILE a full time PhD student? No….I think the IBR and IC plans sound great to people like PhD students and lawyers who come out with tons of debt. It’s only when you see that interest grow- and FAST- that you begin to wonder, “Holy crap….what will my principle balance BE in 25 years….and will my 25 years of payments be rewarded with 5 or 10 MORE years of paying off the IRS?!” My plan is literally to seek tax exempt/non-profit employment after my PhD is completed so I’ll at least have the peace of mind of the 10 year public service loan forgiveness option that is NOT taxed. But like you, Brian, my own father has assured me that many people in our situations have simply NOT made it to that point yet, and it is more likely they will forgive all forgiven loan balances (minus the tax hit) only when more people start running into this problem. Otherwise, everyone is going to be like, “well, I’m 60s anyway, might as well move to Europe already and denounce my credit!” haha I mean, I think they have to fix it. But they are NOT clear enough about interest being an issue for borrowers IMO.

  7. The source of this problem is the outrageous cost of higher education in this country and the exponential annual increase in that cost relative to per capita income. Perhaps if loans for higher education were capped, and given a still weakened national economy and significant unemployment and underemployment, plus the existing inability to discharge student loan debt in bankruptcy, one would think that fewer would be able to afford higher education; and thus the law of supply and demand might force colleges and universities in this country to tighten their sometimes bloated budgets and put the brakes on their staggering annual tuition increases.

  8. Stuart

    It’s the availability of the loans in the first place that caused tuition to skyrocket. The easier it becomes to pay the loans off or have them discharged or forgiven, the less market pressure there will be on institutions to lower tuition or slow its rise.

  9. Tara

    Have you handled cases involving National Collegiate Trust before? I have hired an attorney to defend my lawsuit as they were not the original lender, but there are not any attorneys in my area who specialize in student loan lawsuits. I am wondering what we need to do to have the best shot at beating these lawsuits.

  10. Liz

    While you advocate for using one of the various income based repayment plans to bail one’s rear since bankruptcy isn’t usually a viable option there is a problem with that for some people. As far as I understand, the amount of money you can make a year and stay in that program is capped. If they don’t peg that to inflation or if you, for any other reason, finally end up (while in the income based program) with an income too high to qualify – then what happens?

    I could see starting out in that program or switching to it because of unemployment or low income, but then what happens if you get a job that pays over the income cap to be in the program? I suspect the same rules would apply if you want to voluntarily switch out of the program (eg you have to pay back, in one payment, the amount you had “underpaid” before you could be in a different plan, and you get no credit for all the years you have paid). That, in and of itself could be a substantial problem – as bad as the one that you have to pay taxes on the written off amount, at the end of the required 25 years).

    On the bankruptcy topic – since the government’s own records show that few abused this option and most who used it (and very few did) had overwhelming problems that weren’t going to go away any time soon (catastrophic medical, etc,) I guess I don’t understand why this was removed as an option to begin with and why it is such a big deal to put it back with safeguards in place to deal with the high profile potential high income abuses that occasionally came to light when this was an option. But then again the folks in DC are wealthy enough that they likely don’t have a clue what life is like when you aren’t rich or have a crisis that your family can’t bail you from.

    PS I am the Liz you answered for someone’s column (link is on your media page).

    • Joshua Cohen

      There is no income cap for the income driven programs.

  11. Carl

    I appreciate your critique of the Bank on Students Emergency Loan Refinancing Act, particularly the inability of defaulted private student loans to be converted into federal ones.

    What are your thoughts on the difficulty of rehabilitating private student loans in order to enable any such conversion to federal loans –if the law passes? Theoretically, if allowed to convert, one could lower payments under IBR, etc.

    I do agree with you that it is a hundred times easier to allow bankruptcy discharge of private student loans. One would think that allowing just private loan discharge would have less of an impact on the overall loan market, since it makes up a small percentage of the overall portfolio of student loans.

    What do you think the odds of anything happening with all of the proposed bills that address some of these issues- bankruptcy law- dischargeability or even just more attainable “undue hardship guidance” (something less impossible than predicting future income that seems to be inherent in the Brunner Test), loan conversion rules, credit report changes, or even the reduction of the tax liability at the end of 20-25 years of payments.

    Are we all doomed to bad credit and diving in and out of bankruptcy? Are we left to fend for ourselves trying to find refuge in statute of limitation laws and Chapter 13 plans?

    It just seems to me that student loan law tools are about as useful as screwdrivers are to banging in and removing nails. Hammers exist, but those have been taken away by the bank lobby.