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Government Student Loan Policies Have Perverse Incentives

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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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7 thoughts on “Government Student Loan Policies Have Perverse Incentives

  1. joe says:

    I haven’t refinanced mine because I can write it off in my taxes. I get back about 5k a year and I pay about 420 per month. This is what I was told and why I haven’t refinanced.

    • Rob says:

      If you pay 420 a month and only get 5k back in taxes, you’re maybe breaking even. 420 x 12 is 5,040 a year. You pay interest on your loans but do not get interest on your taxes you get back at the end of the year, so the return is even worse than that. You might want to look into refinancing and see what savings you make both in monthly payments and any interest you may pay in the long therm. Then contrast that with how your tax return will decrease at the end of the year and compare that to what you’re doing now. I suspect, long term, refinancing may save you quite a bit of money.

  2. William Butler says:

    I do not understand how ssomeonecan just refuse to pay their student loans. I took out 2 sstudent loans in the late 1980’s totaling less than $5k. Then became incarcerated for over a decade. These true criminals allowed it to grow to over $52k and are now garnishing my wages. The only one’s benefiting from this crap are the blood sucking bankers.

    • K. says:

      Wow! Unreal!

      • William Butler says:

        That’s what happens when one makes a deal with the Devil. I even had Sen. Ted Cruz investigate it but the DOEd basically told his office to pound sand. So, they are garnishing 10% from each pay check until the $52k is paid. I told them I would never wilfully pay it so they’ll have to take like the criminals they are. So, they are!

  3. Matt says:

    The people that cant afford to pay their student loans, are the same people that moved back home with mommy and daddy, stick their noses in the phone playing Pokemon Go, and go to the bars with all of their other loser friends every weekend instead of taking on responsibility, or starting a family.

    It’s all just really sad. There is no other way to put it.

  4. Jon says:

    Agree with what Matt said above. I spent two years living on oatmeal and doing nothing (no eating out, no entertainment, etc); I also had a couple roommates. It sucked and was boring but I knew I could get out within two years with proper money management. It also taught me a valuable lesson about saving and money management and how to be responsible; a stoic, self restrained lifestyle (due to not affording anything). These ‘adults’ are just kids avoiding “big boy” responsibility. Their resolution: Socialism. From daddy/mommy taking care of them to govt taking care of them. Socialism is going to happen eventually at that point it will be too late.

    When it all comes crashing down it may be a wake up call.

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