Curses, Miracles, and the Best Interest Student Loan Solution

I’m playing with fire here, and not the kind of FIRE usually discussed on money blogs. No, today I want to talk about a student loan solution.

The public discourse on student loans is binary. The status quo is a haunting curse. The proposed solutions are divinely miraculous. I’m going to poke both bears and suggest a third choice.

My idea: People should repay the principal they borrow, but we need to lend a helping hand with the interest.

This proposal checks all the good boxes. The math works. It tiptoes a tenuous line of morality. The government is equipped to enact a program. So, I ask you to consider my proposal. And if you feel like biting my head off, please just grin and bear it.

Not Just A Walk in the Woods

Before we talk about the college loan solution, let’s take a walk. No more bears, I promise.

Every year, thousands of people descend upon the beautiful Adirondack mountains. They seek “silence, solitude, remoteness…intangibles [that] cannot be replicated in many other places east of the Rockies.”

Unfortunately, many of them come unprepared. Long-distance hiking is not just a walk in the woods. And despite gallant efforts at outdoor education, hikers regularly find themselves in over their heads.

Ten miles out in the woods. Not enough food. Not enough water. No warm clothes, no survival skills. It happens every week in the Adirondacks.

If these hikers were student debtors, some people would say, “F*** ’em. You chose that hike. We all gotta die somehow.”

The other side might say, “All hands on deck, all points bulletin, and yank out all the stops. Save them by any means necessary.”

But how does our society actually react?

In reality, a small team of New York DEC rangers hikes out to the persons in trouble, gives them aid if needed, and walks with the troubled hiker(s) back to safety. The rangers help, but they’re not going to carry you (unless you’re injured). And then they ticket you for being unprepared.

It’s not full forgiveness. But it’s legitimate aid for someone in dire straits.

Hmm. How interesting!

The Moral Hazard of Forgiving Loans

People on “the left” (which, somehow, is not a direction, but either an insult or plaudit instead) have suggested sweeping student loan forgiveness. For example, Alexandria Ocasio-Cortez supports:

the Student Debt Cancellation Act of 2019, which would forgive outstanding federal and private student loans of all previous and current students in our education system. By doing so, Representative Ocasio-Cortez and her colleagues plan to liberate generations of Americans trapped in student loan debt and holding back from participating in the greater US economy.

Bernie Sanders supports a similar program, which would:

Cancel all student loan debt for the some 45 million Americans who owe about $1.6 trillion and place a cap on student loan interest rates going forward at 1.88 percent.

But many Americans find a significant problem with these proposals. And, for what it’s worth, I don’t blame those Americans. I get it. There’s a missing sense of justice in the “full forgiveness” proposal. To wit:

1. It would renege on a clear agreement. If I borrow $20 from you, we both expect I’ll pay you back.
2. It would provide more benefits to people who made worse choices. If you borrow $200,000 to attend Harvard, my first question would be, “Does it make more sense to borrow $100,000 and attend a state school instead?”
3. Everything about the college attendance process was voluntary! You chose the school. You chose the major. So should we all bail you out?
4. Why aren’t we bailing out credit card debt? Automotive debt? Let’s pay for everyone’s mortgage, too. If student debtors are receiving trillions of dollars of debt relief, why not other debtors too?
5. Who, exactly, becomes responsible for the cost of school? Students will no longer care—it’s “free” to them. Universities won’t care for the same reasons why they don’t care much now. That is, their customers (the students) have easy access to “free” money! So who becomes responsible? The taxpayer.
6. Related to the last point, what about the rising costs of school? The boomers don’t fully understand this crisis because their 4-year education cost less than a 6-pack of Schlitz. College costs have rocketed through the poorly maintained fraternity roof, and now it’s raining on the pong table.

Do I wholeheartedly believe those six arguments? No.

But I can easily see why other people do. There’s a moral hazard associated with full forgiveness. In economics, moral hazard specifically refers to a lack of accountability or a lack of balance between risk and consequence (famous example: 2008 and the Financial Crisis).

But we can also think about “moral hazard” in terms of traditional morality. Namely, if you borrow money, you should pay it back. Actions have consequences. Circumventing that fact feels amoral.

The Moral Hazard of Letting People Drown

Having described the moral hazard of full forgiveness, let me draw another line in the sand: allowing the student loan crisis to continue unabated is more hazardous than full forgiveness.

But wait a second. The headline up there says “drown.” Drowning? Drowning?! Before, I mentioned legitimate gripes about forgiveness. But now I’m using flowery language to pander to your emotions?

Not quite.

Well, if you told me you were drowning, I would not lend a hand.

Phil Collins

Debt truly is a life and death issue. It might not be deadly today. And not deadly for every person. But there is clear data measuring the negative effects of debt on psychological and physical health.

Next, let’s consult some surveys. Granted, surveys aren’t peer-reviewed data (but neither is pompous bitching from Tucker Carlson). According to a survey of readers from Student Loan Planner, mental health issues and student loan debt are clearly linked. For example, the survey concluded that:

1. 53% of high debt student loan borrowers have experienced depression because of their debt.
2. Nine in 10 borrowers experienced significant anxiety due to their loan burden.
3. One in 15 student loan borrowers surveyed have considered suicide due to their student loans.

Millions of people. Millions of lives. These are our fellow citizens, and they need help. They can’t utilize bankruptcy. We’re chaining them to a cinder block and then telling them the can’t cut the chain! Phil Collins might not lend a hand, but I think Phil’s wrong.

Need Cash Now?

How do you explain $100,000 of loans to a 17-year old? Here’s one way.

Think back to when you were in kindergarten. Can you picture that? Yep, that’s right—12 years ago when Timmy spilled milk on your head.

Ok, now think about every month from that time until now.

And imagine that for every month, you’ve been paying $1200 to a loan servicer.

Ok? Got it? Can you imagine that?

Let me answer for the nation’s 17-year olds:

No, numb nuts! I cannot imagine that. I don’t even remember all my teachers’ names.

You see, it’s been proven (by science!) that humans over-value short-term consequences and under-value long-term consequences. Or, as Bill Gates would say:

We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. 

Bill Gates

Our brains are excited for freshman year freedom, new friends, and interesting classes. Those brains are mildly prepared for the four years of ramen dinner they’re about the consume. But those brains are certainly not considering the ten years of student-loan-induced ramen dinner that follow the first four.

Other Student Loan Troubles

But those in the worst position, needing the biggest student loan solution are those who never finished college.

Some people feel pressured to attend college but find the classwork too difficult. Others need to drop out due to family issues. Some drop out due to financial reasons—their loans simply weren’t enough. And yes, I’m sure some people party too much freshman year and don’t make it.

People without college degrees have average salaries that are $32,000 lower than those with college degrees. College dropouts still have to repay their loans, but must do so on significantly lower salaries.

Do we allow them to drown?

The highest default rates come from student debtors who went to for-profit universities (e.g. University of Phoenix, DeVry, etc). Is it a moral system where we encourage young adults to pursue their dreams, saddle them with debt, and then profit off their plight? Surely that’s a moral hazard.

The Best Interest Student Loan Solution

I don’t support letting people drown. I don’t want them to die in the woods. But I also want to maintain some semblance of accountability. I’ve proposed this solution before, but now I have the power of a calculator so you can see it for yourself.

The Best Interest Student Loan Solution:

We do not forgive loan principal. We do forgive (at least partially) loan interest.

I’m not going to suggest that we forgive the principal of student loan. If I borrow $20 from you, I’ll pay you back.

However, the principal—the $20—is not the problem with student loans. The problem is the interest—or, as I’ve described it before, debt’s “silent assassination technique.”

People are paying thousands of dollars per month against their loans, but sometimes less than 10% goes towards their principal. The rest pays off interest. That’s an issue, and this student loan solution offers a way out.

Example Math from the Student Loan Proposal

Let’s look at an example graduate. This person earns a $50,000 salary, but is $100,000 in debt. Their debt has a 5% interest rate. You know this person. She’s a teacher, or a nurse, or the guy in the office who’s great at spreadsheets. It’s a normal person, and this level of debt is a normal situation.

If this person repays their loans using 10% of their salary—$417/month—they will end up paying a total of $390,000 over 78 years. 

So, let’s apply my student loan proposal. A person paying that same 10% of their salary in my proposal would get 80% of their monthly interest paid by the solution’s government program.

Via the program’s interest assistance, this particular loan would be paid off in 22 years, using $111,000 of the debtor’s funds and $45,000 from the government.

That’s a difference of $233,000 ($390K vs. $111K + $45K) and 56 years of payments. How is this stark difference possible? Because interest is the killer.

Even if you disagree with the details, fine. The truth remains clear: if we help with interest, then repayment becomes attainable.

And in this student loan proposal, the individual is incentivized to pay more if they’re able. If they contribute 12% of their salary—$500/month—then the government covers all interest payments. This particular loan would be repaid in 17 years, using $100K from the individual and $41K from the government. Both the individual and the government save money when the individual pays more.

Note: The actual math is a little more complex than what I could program into this calculator. A spreadsheet with a row for each month is much easier to work with. Because I simplified some things, there are rounding errors above. A few months here, a few thousand dollars there. There are some scenarios at the limits where a few of the numbers don’t quite add up.

How Would It Actually Work?

I think this student loan solution, like what AOC and Sanders recommend, would have to be a government program. Debtors would fill out an application stating their income, assets, etc.

The program would use that application to determine eligibility and determine a mandatory minimum payment that the debtor must contribute. A bracketed approach would be used—the more the debtor pays, the more the government helps. The debtor achieves freedom quicker, but the government also saves money!

Who loses? It’s a zero-sum game. Before, Johnny was paying $150K to a loan servicer. Now, Johnny is paying $100K and the gov’t pays $20K…where does the other $30K go? Answer: it’s money that the loan servicer never receives. The loan servicer loses out.

But Jesse! Free enterprise! You’re putting loan servicers out of business!

I recognize that lending and financing are instrumental to a growing economy. We don’t want to do away with lending. Credit is the grease on which the economic wheel spins.

But we have allowed college loan servicing to grow into a billion-dollar cottage industry. No, really. Companies like Navient are making billions of dollars off of indebted students. And their CEO thinks that building a mansion somewhere far away somehow makes it a “cottage.”

Commencement

It certainly feels like there’s growing Federal momentum creeping towards a student loan solution. There are the status quo curse and the proposed miraculous solution. But in the modern paradigm of binary politics, I urge you to make like Steve Jobs and think different(ly).

There is a middle-ground student loan solution. It’s responsible, both morally and fiscally.

Help with the interest, and repaying the principal becomes possible.

Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.

-Jesse

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