Student Debt 101

Enjoy it, because you'll be paying this off for a long time.

Photographer: Tony Avelar/Bloomberg

President Barack Obama's efforts to reduce defaults on federal student loans are proving popular with borrowers. Unfortunately, that's not such good news for taxpayers: The program's expected costs have just grown by $22 billion. The student-loan system and the administration's approach to reforming it need another look.

To cut defaults and ease the burden of excessive debt, the administration has been encouraging borrowers to switch to income-based repayments, which cap outlays at 10 percent of disposable income. Then, generally after 20 years, the government writes off whatever balance remains.

Student Debt

About a million borrowers took the government up on this offer last year, doubling the number of people benefiting from the arrangement. Defaults are down, though not by much: to 13.7 percent of loans last year, compared with 14.7 percent in 2013. Even though fewer loans are going bad, the elements of added subsidy in the program have driven up the total cost.  

It makes sense for the government to encourage young people to go to college, and it's right to deal compassionately with cases of genuine hardship. But a better deal for taxpayers can be struck.

First, instead of offering affordable income-based repayment as an option, make it automatic, as Republican Senator Marco Rubio of Florida proposed last year. That way, small initial payments from graduates not making much money would be balanced by larger initial payments from graduates making more.

Second, stop forgiving loans after 20 years. For those on low-to-moderate incomes, capping payments in relation to pay is a generous concession in its own right. And the federal government already offers some loan forgiveness to graduates who enter any one of dozens of public-service professions. Adding the promise of forgiveness at a fixed point in time, regardless of the borrower's financial circumstances, is an incentive to overborrow and a disincentive to early repayment. A system that forgave debt in cases of hardship would be defensible, as would allowing student loans to be discharged in bankruptcy (which amounts to the same thing). Automatic forgiveness has no such rationale.

The administration apparently accepts this logic, up to a point: It has asked Congress to delay loan forgiveness for some programs for an extra five years, in the case of loans exceeding $57,500. So long as income-based repayments were made standard, a better policy would be to stop automatic forgiveness altogether.

More fundamentally, policies to ease the burden of student debt need to look beyond the terms of the loans to the price of college. For years the cost of a college education in the U.S. has risen much faster than prices in general, with little or no commensurate improvement in quality. To get a better deal for students, the government should lean more forcefully against this trend -- for instance, by helping students to shop around, and by tying more of the money it pushes into the system to timely completion of degrees and success in controlling costs.

A well-educated workforce is a vital national asset, and supporting that goal is a prudent public investment. But students and taxpayers alike should demand better value for the money.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.