Transcript Document

Lifeboat Drill
Active Debt Management
Mark Kantrowitz
Publisher of Fastweb and FinAid
September 6-7, 2010
Student Loans are Complicated
 Federal education loans have fixed interest
rates, while private student loans have variable
interest rates
 Government pays interest on subsidized loans
during deferments (Perkins 5%, Subsidized
Stafford 4.5%  3.4%)
 Borrower is responsible for interest on
unsubsidized loans but may defer it by
capitalizing it (Unsubsidized Stafford 6.8%, Grad
PLUS 7.9%, Parent PLUS 7.9%)
Borrowing Private Instead of Federal
 More than a quarter of private student loan
borrowers (26.7%) did not borrow federal loans
in 2007-08 even though federal loans are less
expensive
• Three-fifths (60.2%) did not apply for federal aid
 More than a third of private student loan
borrowers (38.1%) borrowed Stafford loans in
2007-08 but less than the maximum available
Stafford loan limits
 91.7% of the parents of dependent students who
borrowed private did not borrow Parent PLUS
Students Misunderstand Loans
 Most students treat loan limits as targets
 Misunderstand variable rates, interpreting
LIBOR + 6% or PRIME + 6% as a 6% fixed loan
• Do not understand why the interest rate increased
 Do not understand capitalization of interest
 Do not understand that years of nonpayment will
cause big increases in the loan balance
 Do not understand how interest works
 Don’t want to think about how they will repay
their student loans until after graduation
Quiz
 What is the total amount repaid on a $10,000
loan with a 10-year term at 10% interest?
A.
B.
C.
D.
E.
F.
$1,000
$11,000
$15,858
$18,100
$20,000
$32,479
Debt Grows with Capitalized Interest
Forbearance
Duration
Capitalized
Interest
Increase in
Loan Balance
Increase in Lifeof-Loan Interest
3 months
$171
1.7%
$236 (6.2%)
6 months
$345
3.4%
$476 (12.5%)
1 year
$702
7.0%
$967 (25.4%)
3 years
$2,256
22.6%
$3,115 (81.8%)
6 years
$5,021
50.2%
$6,933 (182.0%)
9 years
$8,409
84.1%
$11,613 (304.8%)
12 years
$12,562
125.6%
$17,348 (455.4%)
Increases in loan costs from capitalized interest on a $10,000 Stafford loan with
a 6.8% interest rate and a 10-year loan term
Leaving Money on the Table
 Two-fifths (40.9%) of undergraduate students do
not apply for federal student aid
• About a quarter (26.8%) would qualify for a Pell Grant
• 2.3 million would have qualified for the Pell Grant
• 1.1 million would have qualified for a full Pell Grant
 Nearly half of students (46.9%) who submit the
Free Application for Federal Student Aid
(FAFSA) qualify for a Pell Grant
Growth in Cumulative Debt
 65.6% of Bachelor’s degree recipients graduate
with an average of $23,186 in education debt
 Of Bachelor’s degree recipients applying for
federal student aid, 86.3% graduate with an
average of $24,651 in education debt
 86.9% of Pell Grant recipients graduate with
debt ($24,671), compared with 50.2% of nonrecipients ($21,266)
 Pell Grant recipients are 73% more likely to
graduate with debt, and the debt is $3,405
higher
Growth in Excessive Debt
 Borrowing more than $10,000 for each year in
college is excessive
 8.3% of Bachelor’s degree recipients (12.8% of
those with debt) borrowed more than $40,000
 10.3% of Associate’s degree recipients (21.8%
of those with debt) borrowed more than $20,000
 Students who enroll at more expensive colleges,
such as for-profit and non-profit colleges, are
more likely to borrow excessively, as are
independent, minority and low income students
Counseling that Works
 Personalize it with their loan amounts
• Actual monthly payments
• Total interest paid and total payments over the life of
the loan, especially if total interest exceeds the
amount borrowed
 Use rules of thumb that involve simple
comparisons, not math
• Good: “Do not borrow more than your expected
starting salary for your entire education” or “Do not
borrow more than $10,000 for each year of college”
• Bad: “Debt-service-to-income ratio should be < 12%”
Example Repayment Plans
Repayment Plan
Monthly
Loan
Payment
Total
Interest
Total
Payments
Standard – 10 Years
$288
$9,524
$34,524
Extended – 12 years
$254
$11,639
$36,639
Extended – 15 years
$222
$14,946
$39,946
Extended – 20 years
$191
$20,802
$45,802
Extended – 25 years
$174
$27,054
$52,054
Extended – 30 years
$163
$33,674
$58,674
Assumes $25,000 unsubsidized Stafford loan at 6.8% interest and ignores
balance-based setting of extended repayment term.
Tips for Student Borrowers
 Minimize debt. Live like a student while you are
in school so you don’t have to live like a student
after you graduate.
 Borrow federal first, as federal loans are
cheaper, more available and have better
repayment terms. You do not need to be poor to
qualify for federal loans.
 It is cheaper to save than to borrow. Saving
$100 a month for ten years before college will
save you $200 a month for ten years on student
loan payments after college.
Reduce Need for Student Loans
 Every dollar in grants is a dollar less borrowed.
• Search for scholarships on free web sites like
Fastweb.com. Complete all the optional questions to
get about double the number of matches.
• Apply for financial aid even if you think you won’t
qualify or didn’t qualify last year. Enough changes
that you might qualify. The FAFSA is also required for
the unsubsidized Stafford and PLUS loans, which
don’t depend on need.
 Use tuition installment plans instead of loans
 Use Hope Scholarship tax credit, AmeriCorps
Tips for Repaying Student Loans
 Accelerate repayment of the highest cost debt
first, which is usually private student loans and
credit cards. The most expensive debt has the
highest interest rate, not necessarily the largest
monthly payment.
 Stick with the shortest repayment period you can
afford and avoid capitalization of interest
 Use the $2,500 student loan interest deduction
 Sign up for auto-debit for a 0.25% or 0.50%
interest rate reduction
Impact of Extended Repayment
Loan Term
Reduction in Size
of Monthly Loan
Payment
Increase in Total
Life-of-Loan
Interest
Extended Repayment – 12 years
12%
22% (factor of 1.22)
Extended Repayment – 15 years
23%
57% (factor of 1.57)
Extended Repayment – 20 years
34%
118% (factor of 2.18)
Extended Repayment – 25 years
40%
184% (factor of 2.84)
Extended Repayment – 30 years
43%
254% (factor of 3.54)
Impact of extended repayment on monthly loan payment and total interest paid
as compared with standard 10-year repayment
Debt Grows with Capitalized Interest
Forbearance
Duration
Capitalized
Interest
Increase in
Loan Balance
Increase in Lifeof-Loan Interest
3 months
$171
1.7%
$236 (6.2%)
6 months
$345
3.4%
$476 (12.5%)
1 year
$702
7.0%
$967 (25.4%)
3 years
$2,256
22.6%
$3,115 (81.8%)
6 years
$5,021
50.2%
$6,933 (182.0%)
9 years
$8,409
84.1%
$11,613 (304.8%)
12 years
$12,562
125.6%
$17,348 (455.4%)
Increases in loan costs from capitalized interest on a $10,000 Stafford loan with
a 6.8% interest rate and a 10-year loan term
Many Miss First Loan Payment
 One quarter to one third of borrowers are late on
the very first payment on their student loans
• Most student loans have a six month grace period
before repayment begins and students often move
after graduation, losing track of bills
• Borrowers who consolidate their loans are more likely
to pay on time, with less than one fifth missing the first
payment, probably because the first payment is due
soon after consolidation
 Many need a statement or bill as a reminder
 Many do not use auto-debit, despite discounts
Budgeting Tips for High Debt Students
 Review your spending to identify ways to save
money and avoid defaulting on your loans
 Start with a descriptive budget, where you track
and categorize all spending for a month
• Distinguish mandatory spending (need) from
discretionary spending (want) and compare total
mandatory spending with total income
• Identify spending on food, clothing, shelter, health,
transportation, taxes, student loans, entertainment
• Eliminate discretionary spending and substitute lower
cost options (e.g., live with parents to save on rent,
cut gym membership, sell extra belongings on eBay)
End of FFELP, Start of 100% DL
 Since July 1, 2010, all new federal education
loans are made through the Direct Loan
program
 Existing FFELP portfolios are decreasing as
borrowers repay their loans
 Many lenders are trying to reinvent themselves
• Introducing new purely private loan products,
increasing the competition
• Smaller lenders selling loan portfolios
 Tuition increases and stagnant federal loan
limits remain a key driver of private loan growth
Income-Based Repayment (IBR)
 Loan payments capped at percentage of
discretionary income (new plan July 1, 2009)
• Discretionary income is defined as income (AGI)
minus 150% of the Poverty Line for the family size
• Currently 15% of discretionary income, but
decreasing to 10% of discretionary income in July
2014 for new borrowers only
• $0 payment if income < 150% of the poverty line
 Remaining debt and interest forgiven after 25
years in repayment (20 years for new borrowers
on/after July 1, 2014)
Public Service Loan Forgiveness
 Public service loan forgiveness accelerates the
forgiveness for income-based repayment to 10
years and makes it tax-free
• Only federal student loans are eligible. Parent PLUS
loans and private student loans are not eligible.
• Borrower must be employed full-time in a public
service job, such as police, fire, EMT, government,
military, public education, public health, social work,
public interest law, public librarians and 501(c)(3)
• Will yield a financial benefit if debt exceeds income
• Must move loans to the Direct Loan program at
loanconsolidation.ed.gov
Credit CARD Act of 2009
 New requirements to get a credit card, effective
February 22, 2010
• Students under age 21 will need a cosigner age 21+
• Students who can demonstrate an independent
source of funds sufficient to repay the debt will not
need a cosigner
 Sallie Mae survey showed that 84% of college
students have a credit card (average 4.6 cards)
• Average balance $3,173 (median $1,645)
• 17% pay in full each month, 30% charge tuition
• Average debt $4,138 (median $2,495) at graduation
Gainful Employment
 For-profit colleges and vocational programs are
required to prepare students for “gainful
employment in a recognized occupation”
 The US Department of Education is proposing to
define gainful employment in terms of affordable
debt restrictions
• Three strikes rule
– Loan repayment rate ≥ 35%
– Debt-service-to-income ratio ≤ 12%
– Debt-service-to-discretionary income ratio ≤ 30%
• Preferred thresholds of 45%, 8% and 20%
Repeal of Exception to Discharge?
 Congress is proposing to repeal the exception to
discharge for private student loans
 Currently both federal and private student loans
cannot be discharged in bankruptcy unless the
borrower can demonstrate “undue hardship” in
an adversary proceeding
 Less than 1% of borrowers with federal student
loans who file for bankruptcy get their student
loans discharged
 Sallie Mae supports repeal, but without nonprofit
exception and with 5-7 year “good faith effort”
Resources
 FinAid.org (www.finaid.org/loans)
 Student Loan Borrower Assistance Project
(www.studentloanborrowerassistance.org)
 Federal Student Loan Consolidation
(loanconsolidation.ed.gov)
 US Department of Education’s Debt Collection
Service (www.ed.gov/offices/OSFAP/DCS)
 FSA Ombudsman (www.ombudsman.ed.gov)
Thank You
For Mark Kantrowitz’s student aid policy analysis
papers, please visit
www.finaid.org/studentaidpolicy