Who’s To Blame For The Student Loan Crisis?

Vitalik_Dark · Nov 26, 2024

Source: The College Investor

Key Points

Shared Blame: The student loan crisis stems from rising college costs, inadequate government oversight, complex repayment systems, and borrowers’ lack of financial education.
Disproportionate Impact: Low-income, first-generation, and minority students face the greatest challenges in repaying loans, with defaults most common among those who don’t complete their degrees.

Solutions: Addressing the crisis requires policy reforms, simplifying loan programs, increasing financial literacy, and ensuring college affordability through grant aid and controlled tuition hikes.

The student loan crisis is a complex issue with multiple underlying causes. Rising college costs, increased student borrowing, complicated repayment options and a lack of adequate oversight have all contributed to the problem.

Responsibility for this crisis is shared by several stakeholders:

Federal and state governments
Educational institutions
Student loan servicers
Private lenders
Individual borrowers and their parents (who may not fully grasp the long-term implications of their loans)

Colleges have raised tuition faster than inflation, and government grants have failed to keep pace with increases in college costs, pushing more costs onto students and their families. Loan servicers and lenders have also been criticized for misleading practices, and many borrowers lack access to sufficient financial education before taking on debt.

Solving the student loan problem requires a comprehensive strategy, not a single solution. Addressing the problem will require a multifaceted approach involving policy reforms, simplifying the student loan programs, and better regulation of college costs and lending practices. Additionally, increasing financial literacy can help students make more informed decisions about borrowing and repayment.

Ultimately, understanding the root causes of the student loan crisis is key to developing effective and sustainable solutions.

Table of Contents
The Scope Of The Student Loan Problem
The Federal Government
Colleges And Universities
Borrowers (And Their Parents)
Loan Servicers
Solutions To The Student Loan Problem

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The Scope Of The Student Loan Problem

People perceive the growth in student loan debt as a sign of a problem.

Here are the key student loan debt statistics as of the end of last year:

Total Student Loan Debt: $1.76 Trillion
Number Of Student Loan Borrowers: 43.2 Million Borrowers
Total Federal Student Loan Debt: $1.60 Trillion
Total Private Student Loan Debt: $130 Billion
Average Federal Student Loan Debt Per Borrower: $37,088
Median Federal Student Loan Debt Per Borrower: $19,281

Student loans are the second-largest category of household debt, second only to mortgage debt. Student loan debt exceeds outstanding auto loans and credit card debt.

Most college graduates start their careers saddled with tens of thousands of dollars in debt, which can take a decade or longer to repay. The financial burden of student loans can delay major milestones like buying a home, starting a family, or saving for retirement.

The root of the issue may not be the existence of student loans themselves, but rather a college completion problem. The vast majority of college graduates are able to repay their student loans.

Undergraduate students who leave school without finishing a degree are four times more likely to default on their loans than those who graduate. In fact, three-quarters of all defaults are from borrowers who dropped out and did not earn a degree, leaving them with debt but not the credentials needed to boost their earnings and repay it.

Default rates remain stubbornly high, even with income-driven repayment plans, as many borrowers have trouble understanding and navigating the repayment plans.

Still, student loan debt is less widespread than other forms of debt. Only 21.7% of families have student loan debt, while 45.2% carry credit card balances, 40.9% have mortgages, and 34.7% owe on auto loans.

In recent years, new student loan borrowing has declined, with total annual federal student loan debt dropping from its peak of $106 billion in 2011-2012 to less than $80 billion per year. This trend is partly due to fewer borrowers and a decline in the average loan amount for most types of loans, except for PLUS loans.

Nonetheless, the total student loan balance continues to grow, as new loans are taken out each year while old loans are repaid slowly over decades.

Related: Find more student loan debt statistics here.

Source: The College Investor

Impact Of Student Loan Debt

Despite concerns about the broader economic impact of student loan debt, annual student loan payments represent a small fraction of the U.S. GDP. However, the burden on individual borrowers can be substantial, as student loan payments often take precedence over other financial priorities, like paying off consumer debt or building savings. Although the typical student loan payment is lower than a typical car payment, it can still strain the finances of many households.

The impact of student loan debt is not uniform across all demographics. Low-income, first-generation college students, independent students, and borrowers who are Black, Hispanic or Native American are more likely to borrow larger amounts and face greater difficulty repaying their loans. Female graduates are also more likely to have student loan debt and typically earn less after graduation, making repayment more challenging.

When a borrower struggles to repay their student loans, the student loan debt may persist into old age, with senior citizens far more likely to be in default than younger borrowers. According to the Government Accountability Office (GAO), 37% of borrowers aged 65 and older and 54% of those aged 75 and older are in default. The federal government can even garnish Social Security benefits to repay defaulted loans, which is particularly harsh for seniors who rely on these funds for essentials like food and medicine. This practice is both financially harmful and ethically questionable.

Ultimately, the burden of student loan debt increases financial stress and can harm borrowers’ productivity and overall well-being. Addressing the student loan issue requires a nuanced approach, focusing on college completion, improved loan servicing, better financial education, and targeted policy reforms to alleviate the strain on the most vulnerable borrowers.

Here’s a breakdown of who bears responsibility for the student loan problem.

The Federal Government

Over 92% of all student loans are federal, making the U.S. government the dominant player in the student loan market and a central contributor to the current debt crisis. While the federal loan system was designed to make higher education more accessible, it has also led to a significant increase in student debt, with unintended and damaging consequences for many borrowers.

Federal student loans have several characteristics that resemble predatory lending practices. These include granting loans without adequate assessment of a borrower’s ability to repay, high interest rates and fees, interest capitalization, negative amortization, and inadequate disclosures.

For example, unlike private lenders, the federal government does not evaluate the borrower’s debt-to-income ratio or potential future earnings. This makes it easy for students to borrow large sums, often beyond what they can reasonably expect to repay after graduation.

Federal student loans lack many standard consumer protections that apply to other types of loans. For instance:

No Statute of Limitations: Federal student loans do not expire, meaning the debt can follow borrowers for life.
No Defense of Infancy: Even borrowers who took out loans as minors cannot discharge their debt based on age.
Aggressive Collection Powers: The federal government has powerful tools for debt collection, such as garnishing wages, seizing tax refunds, and even withholding Social Security disability and retirement benefit payments. These measures can be devastating, especially for older borrowers who depend on these benefits for basic needs like food and medication.
High Collection Charges: When a borrower defaults, as much as a fifth of the student loan payment is siphoned off to cover collection charges before the rest is applied to interest and the student loan balance. This slows the repayment trajectory considerably, sustaining a high level of debt.

The Parent PLUS Loan and Grad PLUS Loan programs allow for virtually unlimited borrowing, with the only restriction being the total cost of attendance minus other financial aid. The credit checks for these loans are minimal, considering only past credit issues without assessing future repayment ability.

"This creates a moral hazard for students and colleges, enabling families to borrow freely without facing immediate consequences, which in turn drives up the amount of debt."

Federal student loan repayment plans are notoriously complex. While income-driven repayment (IDR) options are designed to make student loans more affordable by basing monthly payments on the borrower’s income rather than the amount owed, they are often confusing and difficult to navigate.

Many borrowers struggle to select the best repayment plan for their situation, missing out on opportunities to lower their payments, reduce interest, or qualify for loan forgiveness. The complexity of the system contributes to missed payments, loan delinquency, and defaults.

For example, over 40% of borrowers are enrolled in the Standard repayment plan, which may cost them more than an income-driven repayment plan.

Percentage of Borrowers Enrolled In each Repayment Plan | Source: The College Investor

Source: The College Investor

In IDR plans, borrowers may find that their monthly payments are less than the accruing interest, causing the total loan balance to increase — a phenomenon known as negative amortization. While remaining debt may be forgiven after 20 or 25 years, the system essentially provides a retroactive grant for over-borrowing, creating long-term financial instability for many.

Policymakers have prioritized student loans over grants as a way to pay for higher education because loans are less expensive to the government in the short term. Government grants have failed to keep pace with increases in college costs, shifting more of the burden of paying for college to students and their families.

Student loans are the only form of financial aid (if you call it that) that demonstrates any degree of elasticity, causing debt at graduation to grow faster than inflation.

Colleges And Universities

College costs have skyrocketed, far outpacing inflation and wage growth. Colleges have continued to increase tuition, knowing that students have access to federal loans to cover rising costs.

Tuition and fees at public and private non-profit 4-year colleges have increased more than 20-fold over the past 50 years. Even after adjusting for inflation, college costs have more than tripled, putting higher education increasingly out of reach for many families.

One major factor driving tuition hikes is the feast-famine cycle of state funding for public colleges and universities. When states face budget shortfalls, they often reduce funding for higher education, forcing public colleges to compensate by raising tuition and fees.

This shifts more of the financial burden onto students and families, leading to a surge in student borrowing. As a result, students are increasingly reliant on federal loans to bridge the gap between the cost of attendance and their ability to pay.

In addition to rising costs, some colleges aggressively market their programs to low-income and vulnerable populations, making promises of high-paying jobs that often fail to materialize. These students, lured in by the prospect of upward mobility, frequently end up with substantial debt but no degree. Without the increased earning potential that a college degree typically provides, they struggle to repay their loans, making them much more likely to default.

Students who borrow heavily but do not complete their degrees are at particularly high risk. They face larger debts relative to the value of their education, leading to financial strain and increased likelihood of default. For many borrowers, this can become a lifelong financial burden, affecting their ability to buy a home, start a family, or save for retirement.

Borrowers (And Their Parents)

Many students rely on student loans to cover tuition, fees, and living expenses. However, some borrow more than what they need to pay the college bills, treating student loans as though they are free money. But, student loans have to be repaid, usually with interest.

The complexity of the system is also a problem, because borrowers don't understand how much they owe or how to track their loan balances.

This confusion often results in underestimating the total debt and the cost of repayment. The lack of transparency and clear communication can leave borrowers overwhelmed and ill-prepared to manage their debt.

Some college students borrow more than they can realistically afford to repay, fueled by unrealistic expectations about their future income. They assume that a college degree will automatically lead to high-paying jobs, but this is not always the case.

This overconfidence can lead to financial distress, especially if their actual post-graduation earnings are lower than expected. Additionally, there is a growing element of moral hazard, where some borrowers believe that their loans may eventually be forgiven or that they will not be held fully responsible for repaying the debt.

Many borrowers choose repayment plans that extend the term of the loan, opting for lower monthly payments without fully understanding the implications. While a longer repayment term may reduce the monthly student loan payment, providing short-term relief, it significantly increases the total interest paid over the life of the loan. In many cases, borrowers end up paying far more than the original amount borrowed, extending their financial burden for years or even decades.

One of the most significant issues is the lack of financial literacy among college students. Many do not fully grasp the terms of their loans or the long-term impact of taking on significant debt to pay for college.

Financial counseling, if provided at all, is often insufficient or poorly timed. This lack of education can lead to overborrowing and difficulties in managing debt, setting students up for financial strain after graduation.

Loan Servicers

Loan servicers also contribute to the problem by lacking transparency in their advice to borrowers. Unlike fiduciaries, loan servicers are not required to prioritize the options that are in the borrower's best interests, and this has led to widespread criticism.

Loan servicers have been criticized for providing inaccurate or misleading information, which complicates the already confusing repayment process. Instead of offering options that could reduce the borrower’s long-term debt burden, servicers often fail to provide clear explanations of repayment plans and their eligibility requirements. Many borrowers report difficulties enrolling in income-driven repayment (IDR) plans, often because they receive conflicting advice or encounter bureaucratic hurdles.

For example, we conducted a survey of student loan borrowers and only about two-thirds were able to understand their student loan repayment plan options:

One-third of student loan borrowers don't know about different repayment plans | Source: The College Investor

Source: The College Investor

Loan servicers have been accused of steering borrowers to forbearance instead of income-driven repayment plans. A forbearance allows the borrower to temporarily pause payments. However, unpaid interest continues to accrue, causing the loan balance to grow. Borrowers are left with a higher loan balance than they started with, digging them into a deeper hole.

Solutions To The Student Loan Problem

There are several solutions that can reduce reliance on student loan debt and make student loans easier to repay.

Expand Grant Aid For Low-Income Students

The federal government should replace loans with grants in the financial aid packages of financially vulnerable students, such as low-income students and current/former foster youth.

A significant increase in the Pell Grant, potentially doubling or tripling the current average amount, would be a critical first step. This increase should be implemented immediately and indexed to inflation to maintain its value over time.

Eligibility should be tied to students from families earning up to 150% of the federal poverty line, ensuring targeted aid without expanding eligibility unnecessarily.

Simplify The Federal Student Loan System

The current system is overly complex, with multiple types of loans and repayment plans, making it difficult for borrowers to make informed choices.

Consolidating the options into two main repayment plans would streamline the process: standard repayment (level payments with a 10-year term) and income-based repayment (10% of the excess of income over 150% of the poverty line, with the remaining debt forgiven after 20 years of payments).

Income-based repayment is intended to provide a safety net for borrowers whose debt exceeds their income.

Implement Sensible Loan Limits

Student loan borrowing limits should be set based on the borrower’s future earning potential, rather than the cost of attendance alone.

Aggregate borrowing should be capped at no more than the expected annual post-graduation income, ensuring that borrowers can reasonably expect to repay their loans within a decade. This would help prevent over-borrowing and reduce default risk.

Annual loan limits should be derived from the aggregate limits.

Eliminate the PLUS Loan Program

The PLUS loan program for parents and graduate students allows borrowing beyond reasonable limits, often leading to excessive debt burdens. Eliminating this program and adjusting interest rates on the Federal Direct Stafford Loan to maintain revenue neutrality would help contain borrowing and focus resources on need-based aid.

Enhance Financial Literacy Education

Requiring comprehensive financial literacy training before students take out loans can help ensure they understand the long-term impact of borrowing. Personalized counseling should be provided, tailored to each student’s financial situation and career plans.

Regular, standardized monthly statements should also be sent during college, keeping borrowers informed about their loan status and the growth of their debt. Increasing awareness of the impact of student loan debt will help borrowers exercise restraint.

Standardize Loan Disclosures

Federal student loans should adopt the same disclosure standards as private loans, offering uniform transparency.

This would provide borrowers with a clearer understanding of the terms, risks, and potential costs associated with their loans, regardless of the lender.

Targeted Loan Forgiveness

Student loan forgiveness should be targeted and needs-based, focusing on borrowers who are truly unable to repay their debt. Priority should be given to:

Low-income borrowers struggling with repayment.
Senior Citizens, particularly those whose Social Security benefits are at risk of garnishment.
Borrowers in essential but low-paying professions, such as public service or teaching in underserved areas.

Improve College Completion Rates

A key factor in student loan default is the failure to reach the finish line. Students who do not graduate are significantly more likely to struggle with loan repayment.

Policies that focus on increasing college retention and completion rates, such as enhanced academic support and advising, can help more students earn a degree and improve their ability to repay loans.

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