Government Student Loan Policies Have Perverse Incentives
Millions of Americans are saddled with student loan payments. And that’s just considering those who can actually repay their debt. Data released in March revealed that 46% of student loans are not currently being repaid.
But despite the squeeze student loan repayment puts on American budgets, few choose to refinance their debt at lower interest rates. A recent poll of American student debtors reported by Bloomberg reveals some interesting reasons why:
There’s no overarching reason why they don’t refinance, though 20.1% pointed to the federal loan option that ties payment amounts to what they’re earning, and they didn’t want to risk losing it. About a quarter of those who answered the poll…said they simply weren’t aware of how to refinance. And 8.4% said they planned to seek forgiveness for their loans. (A third didn’t specify why they weren’t interested in refinancing; only 2% had been rejected when they attempted to refinance.)”
It’s revealing that many with student loan debt spurn the benefits of lowering their interest rates due to government incentives. In other words, we once again have a situation where US policy is creating an unsustainable bubble. The intentions might be good, but the unintended consequences are perverse.
Late last year, a paper published by the National Bureau of Economic Research showed a large percentage of the increase in college tuition is directly related to expanding financial aid programs. This recent poll reveals yet another incentive that exacerbates the problem in the long-term.
Government-backed student loans generally set payments based on income. Make less money, pay less on your debt. Many don’t want to give up this government perk, according to the poll results:
But when asked if they would be willing to give up the income-driven repayment option for the more attractive rate, the results were murkier. The majority, 39.4%, said they weren’t sure that a low interest rate was worth the trade-off. An additional 35.9% said it definitely wasn’t worth it. Only 24.7% said they’d prefer a low interest rate.”
Reading between the lines, it becomes clear that repaying the loan isn’t a priority. Payment management is the overriding concern, regardless of how long it takes to get out of debt. Government repayment plans incentivize extending repayment far into the future, decreasing the likelihood the loans will ever be paid back in full.
It’s telling that more than 8% of those polled plan to seek loan forgiveness.
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Not only is the pile of student debt not being paid down, it continues to grow at an alarming rate, increasing at about $2,726.27 every second. The ramifications of all this debt are already reverberating through the economy. A report in May revealed many parents may end up jeopardizing their retirements in order to help with their kids’ student loan debt.
It’s also important to remember the US taxpayer is on the hook for a lot of this debt. In April, the Obama administration set the stage to forgive nearly 400,000 student loan debtors. It could get worse. A case currently working its way through the federal court system could pave the way for student loan debtors to discharge their obligations through bankruptcy. If that happens, the leaky bubble may well blow up completely.
The bottom line is even if you don’t have student loan debt, it could end up impacting you directly.
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