The Brainless No-Brainer Fix to the Student Loan Problem

fix-to-the-student-loan-problem

You know what they say about opinions, right? Well, the same can be said about so-called no-brainer fixes to the student loan problem, as a recent Bloomberg.com article illustrates.

This particular “fix” has to do with the 57% of federal student loan borrowers who were drop-kicked out of the government’s various income-based repayment (IBR) plans in 2015 because they failed to file their income-verification paperwork on time.

According to the Obama Administration and the departments of Treasury and Education (and that post on Bloomberg.com), the process needs streamlining. How? By permitting borrowers to authorize the Internal Revenue Service to share their tax return data with the private-sector companies that administer their government-backed student loans.

Hang on…

Aren’t we talking about the same administrators that the government had called out for loan-servicing malfeasance?

Hmmm.

And what about requalification as a concept? Why is there even such a thing when loan restructures—which is what we’re talking about here because interest rates and principal balances remain unchanged—are typically a once-and-done affair?

Yes, I know that income-based repayment is income specific. But if we are to take the ED at its word when it says that IBR is the key to achieving a “zero default rate among student loan borrowers,” and if this type of relief plan accomplishes this by extending repayment terms to as long as 20 years’ time — twice the duration of the standard student loan agreement — wouldn’t doubling the remaining term of any student loan yield the same result?

According to the Federal Reserve Bank of New York’s August 2016 report on consumer credit, 11.1% of all student loans are 90 or more days past due. Well, since roughly half of all these loans are actually in repayment (the balance is deferred because the borrowers are still in school), that means that more than 20% of the loans that are “live” are, technically speaking, in default.

Technically, because that’s the way all of the lenders I know treat all other consumer and commercial financings that are three or more payments in arrears.

Add to that, the loans that are between 30 and 90 days past due — because these may well portend future defaults — along with those that are being temporarily accommodated with forbearances (not to mention the loans that have already been granted conditional relief under the various income-based plans) and it’s not hard to see how nearly half of all loans that are currently in repayment are distressed.

A portfolio that is so clearly troubled is one that was improperly structured at the outset. So, if you’re seeking a true no-brainer fix, refinance the whole damn thing.

And not at the rates that are currently being charged, either.

The reason that the government has been reporting multi-billion dollar profits in this sector is because the feds are, in effect, lending long and borrowing short. Back in 2013, Congress devised a plan that charges students for borrowing 10-year money at rates that are roughly commensurate with that duration, only to have the Treasury turn around and fund the ED’s program with significantly less expensive short-term debt.

That the profits from this scheme offset the federal deficit is of course a happy coincidence. And that the government runs the risk of bankrupting its existing portfolio of reduced-rate loans if (and when) short-term rates rise to the point of exceeding those that are implicit within the underlying agreements is also beside the point. Right?

Wrong.

Just as Congress should acknowledge what is painfully obvious about the tenuous condition of these debts and move to refinance all government-backed student loans, so too should it devise an appropriate rate to charge.

It can start by acting like it knows what it’s doing.

Interest rates are built from the ground up. The first building block is the lender’s raw cost of borrowing, which, if we’re talking about 20-year loan terms, is the 10-year Treasury note (lenders use the so-called half-life rate for term loans). Add to that the interest rate equivalents of the costs of originating and servicing these contracts, along with a reasonable estimate for losses.

Here’s how the numbers shake out.

At the time of this writing, the 10-year Treasury note yielded 1.8%. Also at the time of this writing, the ED is charging slightly more than a 1% upfront fee for originating undergraduate student loans (a 0.1% interest rate add-on), and loan servicers are typically paid 1% for administering contracts of this type (another 0.1% interest rate add-on). As for the losses, let’s say that the government is wrong about zero defaults and put that number at 10%—higher than for any other form of consumer debt. The interest rate equivalent of that is 1.0%. Add up the pieces and you get 3.0%.

Wait a minute…

That means that the 3.76% rate that Congress concocted for the ED to charge at this time for its 10-year Federal Direct loans is overpriced by a whopping 25%. And that’s without taking into effect the fact that the pricing basis for 10-year loans should have been the 5-year Treasury note, which costs about a half a point less than the 10-year instrument.

All the more reason to reject this no-brainer fix and do what truly needs to be done: Permanently modify the contracts that are currently in place and adjust the existing program’s terms to match.

And one more thing.

Let’s not punish the roughly 50% of borrowers who are not having difficulty making their payments by forcing them to incur higher aggregate interest costs over the newly extended term. Instead, pave the way for them to continue paying what they’ve been paying by mandating that loan servicers automatically credit all supplemental remittances against principal (when no other payment-related obligations such as late fees are outstanding), rather than against future payments as is often the case.

Just because a borrower may neglect to specify his intent, or fail to realize that paying ahead on a loan is akin to remitting interest that has yet to be earned, shouldn’t mean that the lender or its subcontracted loan administrator is entitled to selfish advantage.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

Image: Jacob Ammentorp Lund

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62% of Kids Expect Their Parents to Just Pay for Their Dream School

kids-expect-their-parents-to-pay-for-college

With the price tag of a good college education seemingly always on the rise, it’s no wonder families worry how they’ll cover this major expense. But, according to a survey by T. Rowe Price Group, a global investment management firm in Baltimore, it’s a concern that most students believe should fall on their parents. In fact, 62% of kids expect their parents to pay for “whatever college I want to go to.”

The College Board reported that the average full cost for a 4-year in-state school is about $80,000. Only about 35% of parents who took part in the eighth annual T. Rowe Price Parents, Kids & Money survey realized it cost this much.

The survey also found that more than half of parents (58%) are saving for their kids’ college tuition, yet only 12% of parents reported being able to cover the full cost of their child’s college tuition.

“It’s surprising that most kids expect their parents to cover whatever college they want to go to — and presents a real opportunity to discuss family finances and make sure everyone is on the same page,” Judith Ward, a senior financial planner at the T. Rowe Price Group, said in a press release.

Methodology

From February 4 to February 11, 2016, MetrixLab surveyed 1,086 parents and 1,086 kids ages 8 to 14 in the U.S. on behalf of the T. Rowe Price Group. The margin of error for the survey is plus or minus three percentage points. Testing done among subgroups (i.e. boys vs. girls) is conducted at the 95% confidence level, and the report only includes findings that are statistically significant at this level.

Paying for College

It’s a good idea for parents to discuss their financial situation with their kids and consider all options when deciding on a school, as no one wants to drown in debt after graduation.

It’s also important to remember the effect student loans can have on your credit score. Sure, these loans can help diversify a credit profile, but it’s also good to remember that defaulting on one can be extremely damaging to your credit scores. These scores come into play for many of life’s major milestones, like taking out a mortgage or car loan, and some employers even look at a version of your credit report as part of the application process. To keep an eye on how your financial habits are affecting your credit, you can view your free credit report summary, updated monthly, on Credit.com.

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The Student Loan Default Rate Is Way Worse Than You Think

The Wall Street Journal’s Josh Mitchell recently authored an article in which he calls attention to the roughly 16% student loan debt default rate, as measured in terms of number of borrowers.

That data point, by itself, is extraordinarily high. In proper context, it’s calamitous.

At $125 billion in aggregate value, these defaulted loans represent roughly 10% of all student loans that are currently outstanding — and roughly 13% of those that are government-guaranteed. Yet only about half these debts are actually in repayment (because the other half represents deferred borrowings for students who are still in school). As such, that 10% (or 13%) is really closer to 20% (or 26%).

That’s nearly double the default rate for single-family mortgages at its height, in the aftermath of the 2008 economic collapse. Here too, though, that metric is also misleading.

For all other forms of consumer debt — commercial debts as well, for that matter — defaults are measured on contracts where the payments are 91 or more days past due. Only within the unique alternative universe of government-backed student loans are defaults measured at 270 or more days.

Therefore, if the Federal Reserve Bank of New York is correct at noting in its most recent Quarterly Report on Household Debt and Credit that seriously delinquent student loans (more than 90 days past due) represent 11% of all outstanding education debts, and if that metric excludes loans that have already been declared to be in default, the most accurate default rate lies somewhere between 40% and 50%.

Hence my use of the word calamitous.

Would Free College Tuition Solve the Problem?

With all due respect to both Secretary Hillary Clinton and Sen. Bernie Sanders, the notion of free tuition for higher education does nothing for those who are already encumbered.

All these debts — without regard for origination channel (public vs. private) and payment status (current vs. past-due) — should be restructured so that:

  • Installment payments are made over 20 years instead of 10
  • The interest rate represents the true breakeven point for the government
  • Borrowers have the option to accelerate repayment without penalty

Even if lawmakers decide to reduce the 20-year restructure term by subtracting twice the number of months that have been paid to date, the net effect on all borrowers will be significant.

It’s the difference between debts that are more likely to be repaid than not, major consumer purchases that are more likely to be undertaken than not, and a taxpayer-funded bailout that would otherwise be more likely than not.

As for all the free tuition rhetoric? According to a recent Princeton Survey Research Associates report, 62% of those surveyed love the idea, although nearly half are unwilling to cough up the money (in the form of higher taxes) to pay for it.

Therefore, the only way to make this ideal a reality is to attack the cost side of the equation.

We can start by encouraging institutional consolidations to eliminate operational redundancies, eliminating tax breaks for endowment funds and requiring that the income these investment funds generate are used to offset the price of tuition.

At that point, not only will we have addressed the problem that exists today, but we will have also taken steps to help ensure against its recurrence.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

Image: Lorraine Boogich

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The Student Loan Default Rate Is Way Worse Than You Think

The Wall Street Journal’s Josh Mitchell recently authored an article in which he calls attention to the roughly 16% student loan debt default rate, as measured in terms of number of borrowers.

That data point, by itself, is extraordinarily high. In proper context, it’s calamitous.

At $125 billion in aggregate value, these defaulted loans represent roughly 10% of all student loans that are currently outstanding — and roughly 13% of those that are government-guaranteed. Yet only about half these debts are actually in repayment (because the other half represents deferred borrowings for students who are still in school). As such, that 10% (or 13%) is really closer to 20% (or 26%).

That’s nearly double the default rate for single-family mortgages at its height, in the aftermath of the 2008 economic collapse. Here too, though, that metric is also misleading.

For all other forms of consumer debt — commercial debts as well, for that matter — defaults are measured on contracts where the payments are 91 or more days past due. Only within the unique alternative universe of government-backed student loans are defaults measured at 270 or more days.

Therefore, if the Federal Reserve Bank of New York is correct at noting in its most recent Quarterly Report on Household Debt and Credit that seriously delinquent student loans (more than 90 days past due) represent 11% of all outstanding education debts, and if that metric excludes loans that have already been declared to be in default, the most accurate default rate lies somewhere between 40% and 50%.

Hence my use of the word calamitous.

Would Free College Tuition Solve the Problem?

With all due respect to both Secretary Hillary Clinton and Sen. Bernie Sanders, the notion of free tuition for higher education does nothing for those who are already encumbered.

All these debts — without regard for origination channel (public vs. private) and payment status (current vs. past-due) — should be restructured so that:

  • Installment payments are made over 20 years instead of 10
  • The interest rate represents the true breakeven point for the government
  • Borrowers have the option to accelerate repayment without penalty

Even if lawmakers decide to reduce the 20-year restructure term by subtracting twice the number of months that have been paid to date, the net effect on all borrowers will be significant.

It’s the difference between debts that are more likely to be repaid than not, major consumer purchases that are more likely to be undertaken than not, and a taxpayer-funded bailout that would otherwise be more likely than not.

As for all the free tuition rhetoric? According to a recent Princeton Survey Research Associates report, 62% of those surveyed love the idea, although nearly half are unwilling to cough up the money (in the form of higher taxes) to pay for it.

Therefore, the only way to make this ideal a reality is to attack the cost side of the equation.

We can start by encouraging institutional consolidations to eliminate operational redundancies, eliminating tax breaks for endowment funds and requiring that the income these investment funds generate are used to offset the price of tuition.

At that point, not only will we have addressed the problem that exists today, but we will have also taken steps to help ensure against its recurrence.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

Image: Lorraine Boogich

The post The Student Loan Default Rate Is Way Worse Than You Think appeared first on Credit.com.

Should I Use Home Equity to Pay My Kid’s College Tuition?

home-equity-or-HELOC-to-pay-for-college

Q. What are the pros and cons of a home equity loan instead of a home equity line of credit? I’m thinking of using it for college tuition.
— Parent

A. Deciding the best place to take money to pay for college tuition is a hard decision that can stick with you for years after the student graduates.

You’re talking about taking funds from the value of your home to pay the tuition bills.

There are differences between a home equity loan and a home equity line of credit, or HELOC.

With a HELOC, the amount of the loan is basically your credit line and you draw on the credit line only when you need the money, said Sheri Iannetta Cupo, a certified financial planner with SageBroadview Financial Planning in Morristown, New Jersey.

The rate on a HELOC is variable.

“It is usually based on the prime rate plus or minus a factor, therefore there is the risk that the rate will rise while you are paying back the loan thereby increasing your expected monthly payment,” Cupo said.

Your monthly payments for a HELOC cover interest only during the draw period.

“This provides flexibility, but we recommend you pay more than the monthly required payment so you don’t dig yourself into a hole,” she said.

A home equity loan, in comparison, comes with a fixed rate and you get the funds in a lump sum. You’d also be in a regular payment plan the repay the money.

“A home equity loan could jeopardize need-based financial aid as the money received from the home equity loan that is not yet used to pay for college will negatively impact the FAFSA,” she said.

With either kind of borrowing, your home is collateral for these loans. If you cannot pay your loan then you could lose your house, Cupo said.

And if the value of your home falls, she said, you could end up owing more than your home is worth.

“Interest is generally deductible when these loans are used for college unless you are subject to Alternative Minimum Tax (AMT). Then home equity interest is only deductible when used to improve your home,” she said. “Home equity indebtedness — as opposed to a mortgage used only to buy or build a home — is only deductible on amounts up to $100,000.”

So which is best for you? That depends on your situation. Consider meeting with a financial adviser who can go over your entire financial picture to help you make the most informed decision for your family.

[Editor’s Note: Remember, missing payments on a home equity loan or HELOC can hurt your credit. You can see how your credit currently fares by viewing two of your credit scores for free each month on Credit.com.]

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What’s the Best Way for Grandma to Gift My Kids Money for College?

529-plan-tax-benefits

Q. My mother wants to gift my two kids $50,000 each for college. I know there can be tax and financial aid consequences. Any advice on the best way to do this?
— Lucky

A. Your mother has several options.

The best way really depends on what is most important to your mom, said Mary Scrupski, the director of estate planning with Prestige Wealth Management Group in Flemington and Millburn, New Jersey.

Scrupski said if your mom just wants to help your children with their education, she could set up a 529 plan for each child and contribute $50,000 to each account.

529 plans are tax-deferred accounts that are earmarked for education, Scrupski said. Earnings are not subject to federal income tax and generally are not subject to state income tax when used for the qualified educational expenses of the designated beneficiary such as tuition, fees, and books, as well as room and board, she said.

“If your children are young, the account could grow free of income tax for many years before it is needed,” she said. “This is a very tax-efficient way to pay for education.”

But there are gift tax concerns in setting up the plan, Scrupski said.

In general, your mother can give each child $14,000 a year without using up any of her lifetime gift/estate tax exemption, she said, but there is a special rule for contributing to a 529 plan.

“If she contributes the $50,000 in the first year, it will be pro-rated over the following five years at $14,000 a year,” Scrupski said. “This limit has much less impact, however, than it used to because the federal estate and gift tax exemption amount is now $5.45 million.”

Scrupski said that payment of tuition directly to the educational institution is not a taxable gift at all, no matter how large the payment, so this is another option.

But the direct payment of tuition would most likely jeopardize any financial aid the child would be eligible for based on need, she said.

“If financial aid is a concern, then a 529 plan account might work so long as your mother is the custodian, and not a parent,” she said. “If the parent is the custodian, the plan will most likely be considered an asset of the parent and will have to be reported on the child’s financial aid application.”

Once payments were made, however, out of the account, then this would be considered income to the child and would impact his or her financial aid, Scrupski said.

“Planning for financial aid can be challenging because each school has its own rules,” Scrupski said. “Your mother might want to wait until the child is out of school completely and then possibly gift the child the funds to pay his or her student loans or make gifts for other purpose such as a down payment on a house or a wedding, instead of paying for school if the child is likely to receive financial aid.”

Your mom may want to work with her accountant or tax attorney before gifting anything, said Vicky Tomaro, an investment adviser representative with Tomaro Financial Group in Wall, New Jersey.

If your mom gives more than the annual gift exclusion amount — if it’s not part of the special 529 five-year giving rule — it could affect your mom’s estate long-term, Tomaro said.

More Money-Saving Reads:

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My Kid Doesn’t Want the Money I Saved for His College. What Now?

change-529-plan

Q. I have two kids and one of them is refusing my help for college bills. I have probably half of what he needs in a 529 plan. His sibling also has a plan. Should I change this sibling to be the beneficiary or should I wait in case he changes his mind?
— Mom

A. College is a very expensive proposition, and we’re wondering how your son plans to pay for it all.

Depending on the answer to that question and the expected cost of college for each of your children, you may want to wait before you make a move.

Changing beneficiaries on a 529 plan is not a hard thing to do, but you can take some time to decide if it’s the right thing to do, said Bill Connington of Connington Wealth Management in Paramus, New Jersey.

He said most plans will allow you to change beneficiaries with a form, and depending on the plan, you may have to pay an administration fee.

As a rule, Connington said, changing the beneficiary of an account can result in a gift or worse. But with a 529 plan, the account owner can change the beneficiary without tax consequences if the new beneficiary is a member of the family of the old beneficiary.

A member of the family is defined in IRS Code Section 529, but includes, among others, siblings, decedents, parents and cousins.

So for you, it seems there wouldn’t be tax consequences if you make the beneficiary change among siblings.

“If the new beneficiary is not a member of the family, the change will be treated as a non-qualified distribution and the earnings portion of the account will be subject to income tax and a 10% penalty,” he said.

But back to your son’s decision.

You should try to sit down and run some numbers with him. See what kinds of scholarships or grants he can expect, but then take a close look at the costs of borrowing. Look at how student loans will accumulate over time, what the monthly payment is likely to be upon graduation and how this will impact your son’s budget after college.

He may change his mind when you run the numbers together.

[Editor’s note: Keep in mind there are limits on how much a student can borrow in federal education loans, and getting private student loans often requires having good credit or a co-signer with good credit. Taking on student loan debt can also have a significant impact on your future credit health, so it’s smart to keep an eye on your credit before you borrow and as you’re paying off education debt. As part of your regular credit checkup, you can see two of your credit scores for free each month on Credit.com.]

More on Student Loans:

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The Teen Who Got Into All 8 Ivy League Schools

Ivy League schools

The Ivy universities are notoriously challenging to get accepted to, but a New York student took it one step further and did the nearly impossible: she got into all eight.

August Uwamanzu-Nna from Long Island, New York was accepted to the eight Ivy League schools, as well as her four backups — New York University, Johns Hopkins University, Rensselaer Polytechnic Institute and the Massachusetts Institute of Technology.

“I’m still quite unsure what school I’m going to attend, but I know attending any of them would be such a great honor,” Uwamanzu-Nna told News 12 Long Island.

The 17-year-old valedictorian has a weighted 101.6 GPA and credits her success to family and teachers.

“The teachers make sure our potential is met and that we have done everything in our abilities to achieve success,” she said.

She currently attends Elmont Memorial High school in Long Island, which had another student, Harold Ekeh, also accepted to all the Ivy’s last year and ultimately opted for Yale University. Uwamanzu-Nna plans to visit each of the schools this month to see which one she’ll say “yes” to by the May 1 commitment deadline.

Ivy League schools don’t offer merit scholarships but use factors like family income, assets and size to determine each student’s need for financial assistance. There are other colleges who charge more in yearly tuition than Ivy League schools, but tuition is still pretty expensive. The priciest choice at the moment is Columbia University with $51,008 and the cheapest is Princeton at $43,450 (in terms of total tuition and fees for a year).

No matter which school students decide to attend, cost is certainly an important factor. More than 43 million Americans have student loan debt, many of whom carry debt loads that will take years to pay off. While student loans can do good things for your credit scores, they can also have a major negative impact on grads’ credit if they miss payments or default. You can see how your student loans are impacting your credit scores for free on Credit.com.

More on Student Loans:

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I Can’t Afford to Go to My Dream School & I’m Freaking Out

graduation_cap_and_checkbook

Figuring out where to go to college is a very long process, and this is the home stretch. But for many students trying to decide where to go to school in the fall, this time of year is also the worst part. The journey that started out with so many exciting (albeit stressful) unknowns is coming down to a few hard, cold facts: where you’ve been accepted, how much money the school is giving you and how much money you’re going to have to spend to go there.

There’s no more wondering if or hoping you’ll get more scholarships, grants or generous aid packages. There’s just a lot of math with big numbers and the possibility that you’ll be in a lot of debt by the end of all this. As the financial aid award letters started arriving at her home a few weeks ago, one high school senior started to worry she’d end up in much more debt than she originally thought.

Delilah, a 17-year-old from Maryland who asked we not use her last name because she’s still waiting to hear from some schools, didn’t get any financial aid other than unsubsidized federal student loans from the first two schools that sent her letters. Still waiting to hear from her dream school — $64,000-a-year Oberlin College — she started to worry there was no way she’d be able to afford the schools she loved. In matter of days, the excitement she’d felt for months about going to college evaporated.

“I’m more nervous now,” she said. “I don’t know what’s a large amount of student loans. … How much is the debt going to screw up my financial life?”

As happens to so many students and their families, Delilah’s Expected Family Contribution (determined by information filled out on the Free Application for Federal Student Aid, aka the FAFSA) is much higher than what her parents told her they’d pay for college. Her EFC is $60,000 for the next academic year (it’s determined on a yearly basis). Her parents said they’d give her $10,000 a year.

“It’s kind of catching them off guard,” Delilah said. She’s the oldest child in her family, and her dad worked through college to pay for it. “They thought it was totally reasonable to have me pay my way through college.”

Now that her potential schools are sending her financial aid award letters, she and her parents see she may need a significant amount of federal student loans to pay for school. She has some scholarships and merit awards, and she can get varying amounts of college credit through her AP scores and some community college classes she’s taking, but this, combined with the federal student loans and her parents’ contribution won’t cover everything, it seems.

On top of all that, Delilah wants to study history and doesn’t expect to have a lucrative career. She’s struggling to grasp what’s an acceptable amount of student loan debt, but it’s hard for her to process working with such massive sums of money.

“I feel like right now I wouldn’t want to take on more than $40,000 or $50,000 [in debt] but I’m not used to dealing with this much money, ” she said. “I know people who think that $150,000 of student loan debt is the total norm.”

It’s not. The average student loan borrower from the class of 2015 owes about $35,000, according to an analysis of government data by Mark Kantrowitz, publisher at Edvisors — though those six-figure debt loads aren’t unheard of, even for undergraduates.

This is Delilah’s biggest financial decision so far, and she has to make it soon. For months she’s had her heart set on Oberlin, but with a month left before she has to commit, she’s trying to figure out how to love other schools.

“I don’t want to come down to going to a school I don’t like, but finances are the biggest thing right now,” she said. With AP credits and lower tuition, the in-state school she applied to, St. Mary’s College of Maryland, could end up being significantly cheaper than her first-choice Oberlin. Still, Oberlin is her favorite. She has a lot to think about and little time to make a decision. “It really frustrates me. I think the price of college is just ridiculous — it blows my mind.”

We’re going to check in with Delilah in the coming weeks as she finalizes where — and how much she’ll pay — to go to college. (You can see how your student loan debt may be affecting your credit scores by viewing your free credit report summary, updated each month, on Credit.com.)

More on Student Loans:

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