Obama's Proposed Student Loan Debt Remedy Carries a Hidden Trap

Daily Finance ^ | 04/16/2013 | by Bruce Watson

[SeekAndFind]

America's student loan debt problem is nothing new: For years, the media has been offering up a flood of stories about people facing decades of debt repayment and crushing interest rates. But with tuitions still rising and employment options for college grads still stagnating, America's potential "student loan bubble" is making many experts increasingly jittery. President Obama's recent budget proposal includes a new plan to tackle the problem, but some critics worry that it could leave students in even worse shape.

Pay As You Earn, President Obama's first stab at the student loan issue, came late last year. The program caps student loan repayment levels at 10 percent of the borrower's discretionary income, effectively ensuring that recent graduates won't get stuck with brutal monthly payments. At the same time, the program also places an effective limit on the length of repayment: After a student has been paying off their debt for 20 years, the program will retire any debt that remains.

It's a great idea, and could go a long way toward ending the student loan debt carousel that so many workers are stuck on. Unfortunately, there are some rather severe caveats. To begin with, Pay As You Earn is only available to students who have taken out at least one student loan after fiscal year 2011. In other words, people who are already in repayment hell are stuck there.

Also, the program only applies to federally backed student loans, which means that many people struggling under the worst loan debt -- those who took out higher-interest private loans -- are ineligible.

What the President Proposes

Last week, President Obama debuted another balm to ease student-loan miseries, but the remedy is paired with another potentially devastating long-term consequence.

Here's how it would work: Currently, Congress sets a cap on student loan interest rates, but Obama's proposal would peg student loan interest to the market. Under the proposed system, 10-year Treasury notes would be the benchmark for loan interest. The interest rate on subsidized Stafford loans would be the Treasury note rate, plus 0.93 percent; on unsubsidized Stafford loans, it would be Treasury rate plus 2.93 percent; and on loans to grad students and parents, it would be Treasury plus 3.93 percent.

Today, the Obama proposal would be a considerable benefit to students. It would lower the subsidized Stafford loan rate by 0.65 percent, the unsubsidized Stafford rate by 2.05 percent and the grad rate by 1.05 percent. The trouble is that the Treasury note interest rate is currently near historic lows and is almost certain to rise if the economic rally ever kicks into gear. As The Atlantic noted, there are times during the past few decades when -- under the proposed plan -- student loan interest rates would have jumped above 12 percent.

It's also worth noting that Obama's interest rate proposal doesn't do much to address a basic problem of student loan repayment. Students who attend school during economic boom times but have to repay their loans during economic busts could easily find themselves trying to service high-rate loans at the worst possible times. This, incidentally, is a big part of the problem now: Many students who took out loans at 8 percent or higher during the 1990s and 2000s are in repayment mode when interest rates are low and hiring is sluggish.

Ultimately, Obama's policies for college students and recent grads are proving to be a mixed bag. Pay As You Earn has the potential to completely transform the student loan landscape, effectively promising that the next generation of college graduates won't face the same Sisyphean economic task as the one the preceded it. On the other hand, the president's interest rate proposal risks undoing much of the good inherent in Pay As You Earn.

Either way, it won't really matter to young people recently arrived in the job market: Stuck with heavy loans at unserviceable rates, they're likely to remain out in the cold, trying to pay down their debt, without any real hope of escaping a brutal economic treadmill.

[faithhopecharity]

if we can only get O and the federales OUT of market manipulation!!! they are (deliberately trying to, it seems quite clear) destroy(ing) the American economy with all this interference

[NEMDF]

I have several problems with this plan proposed by 0bama. First of all, the issue of limited payments to 10% of “discretionary income”, should be something like net income after required taxes withheld. IIRC the discretionary income is whatever is left after paying all the normal bills, rent, cell phones, car payments, etc. The whole program, if subject to this type of pay-back requirement, will necessitate THOUSANDS of federal employees to analyze what people should be paying. The forgiveness clause after X many years, just means that the rest of us who work and pay taxes will have, again, subsidized the loans.

[Graewoulf]

Arrogant, Incompetent, Communist Tyrant B. Hussein Obama Nationalized the Student Loan Program and Debt a few years back.

Since then the student debt, loans and job prospects have gotten worse.

Obamanation has failed again.

Thus, it is time to re-privatize the Student Loan Program, and thus reduce the tax burden on those of us who still foolishly pay taxes to the Communist Obamanation of unlimited Debt and Doom.

[SMARTY]

Kids need to QUIT financing college on the backs of taxpayers, and STOP creating debt for themselves!

Go out after HS and GET A JOB so you can fund your OWN EDUCATION.

You'll graduate DEBT FREE.

Now, it will take a little longer and maybe college won't be that 4 year long (or longer) frat party you thought we all owed you... but you can walk away with your future unencumbered by debt!

[ThisLittleLightofMine]

Kids aren’t carrying the debt it is the parents.

[The Antiyuppie]

” You’ll graduate DEBT FREE.

Now, it will take a little longer and maybe college won’t be that 4 year long (or longer) frat party you thought we all owed you... but you can walk away with your future unencumbered by debt!”

The problem with this, is that now, you will be an adult and have “too much money” for financial aid (not loans). You can get in a situation where you work, scrimp, save, and come out net zero or even worse off. Nice, huh? What a great life lesson for young people to learn!

[wny]

here’s a good plan: you borrow money, you pay it back.

[stop_fascism]

If you don’t want to have loan payments, don’t borrow money. If you must borrow money for college, don’t major in women’s studies, queer studies, communications, etc.

[lodi90]

Go out after HS and GET A JOB so you can fund your OWN EDUCATION.

You’ll graduate DEBT FREE.

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Have you checked out how much tuition is these days?

It would be a lot longer than 4 years working part time to pay for it. Public colleges are pushing $10k a year for only tuition in my neck of the woods. A huge tuiton bubble has been created by the gov. subsidies.

[Buckeye McFrog]

Eventually the number of underwater borrowers will reach critical mass and vote themselves loan forgiveness.

[ModelBreaker]

This program is insane.

1. It is a subsidy (even worse than today) for people to take college majors that will never produce income. They have low payments for 20 years and then the principal is forgiven. Essentially, the ACORN/AWS crowd can live on the government teat while they are “students” and then barely pay anything back.

2. Students who make something of their lives pay the whole loan.

3. Students who make something of their lives pay higher interest rates.

4. The burden will end up on the taxpayer and on the students who make something of their lives. The students who take gender studies get a really nice subsidy for six years that will not have to be paid off in full.

Great program.

[lodi90]

Essentially, the ACORN/AWS crowd can live on the government teat while they are “students” and then barely pay anything back.

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This is exactly how the socialists do it in places like Greece, France and Spain. A huge chunk of the population are full time “students” well into their 30s.

[SMARTY]

Yes, it’s a vicious circle. The schools keep piling on costs and the gov’t keeps handing out the grants... kids STILL can’t make it on their own.

I paid my own way and it DID take longer... but that was then.

The system certainly IS broken, but the obstacles are NOT insurmountable.

A great many young people feel their are owed this extra added trip to Disneyland before they join the ‘grown-up’ world.

They can and should take up as much of the cost as possible. A free ride is NOT good for them or us.

[The Antiyuppie]

“This is exactly how the socialists do it in places like Greece, France and Spain. A huge chunk of the population are full time “students” well into their 30s.”

They do this to wait it out until the job market gets better...which of course, it never does.