When Kyle McCarthy graduated with a master's degree from the University of San Franciso's business school, he dreamed of becoming an athletics director. But just four months after graduation, in April 2007, he slipped and tore his meniscus and two ligaments while playing soccer. It was a slip that would end up costing him his livelihood.
Bedridden for two months while awaiting surgery, McCarthy was unable to work. Meanwhile, the six-month grace period elapsed on his undergraduate and graduate student loans, which totaled $72,000. According to McCarthy, he unsuccessfully tried to put them into forbearance, then missed his first two payments amid the stress and confusion of having surgery. Suddenly, his monthly payment ballooned by several hundred dollars. His mother couldn't afford to fly out from Maryland to see him, let alone help him financially. And so McCarthy began a painful spiral into default.
"This has been the most horrible, demoralizing thing I've ever been though," he said. "Once you stumble, it's over. And you have no way out."
Today, two of McCarthy's loans are in default, and another is in delinquency. In order to get them in "good standing," he'd have to pay thousands of dollars. But he's nowhere near able to meet his obligations, as he only earns $14.75 an hour from his job at Borders bookstore. "I want to pay what I owe, but they're asking for too much," he said. "And they won't negotiate with me."
McCarthy, 28, is one of a growing number of people who have taken out large loans to fund their educations but are having difficulty paying them back. The reasons are numerous: Tuition rates have been rising for years at roughly double the rate of inflation, while federal grants have declined. Student loans are easily approved, and low interest rates make them an attractive alternative to credit cards. These days, more than two-thirds of all college students are borrowing; the average undergraduate borrows $23,000 and graduate students borrow about $40,000. Meanwhile, variable rates, hidden fees, and the growth of private loans have created incentives for lenders to make risky loans, leading to predatory lending.
The results of this simmering situation could spell a financial meltdown similar to the sub-prime mortgage crisis. At roughly $850 billion outstanding, student loan debt recently surpassed credit cards as the nation's largest segment of consumer debt. And a big chunk of that is in default — about $61 billion in federal and private loans, according to Mark Kantrowitz, founder of the student loan advice web site FinAid.Org. Like the victims of the sub-prime mortgage crisis, students were lured by the promise of a more lucrative tomorrow to borrow money against a future that never materialized. The most notable difference is that student loans are notoriously difficult to avoid repaying since they aren't easily dischargeable in bankruptcy. In the end, however, we'll all likely have to deal with the consequences.
How We Got Here
In 1965, President Lyndon Johnson signed the Higher Education Act, which provided grants and scholarships to help more students go to college. It also authorized private banks to make student loans, and created the Federal Family Education Loan Program (FFELP) to guarantee these loans, so that if a student defaulted, the bank would be repaid almost all of the principal. In 1972, the government created SLM Corporation, commonly known as Sallie Mae, to purchase these loans from banks, and thereby expand the amount of credit available.
While Sallie Mae began as a federal entity, it took steps to privatize in the Nineties and completed the process in 2004. In the meantime, Sallie Mae became a giant of the lending industry, with tremendous stock growth and profits. From 1995 to 2005, the company's stock rose 1,600 percent. Part of that growth was attributable to favorable legislation that Sallie Mae helped push for.
"Sallie Mae essentially wrote the laws that paid it," said Barmak Nassirian, of the American Association of Collegiate Lenders and Registrars. "The reason that Sallie Mae was so phenomenally profitable in the 2000s had to do with the fact that it had friends in the Congress."
One of those friends is Congressman John Boehner, the likely new speaker of the house and former chairman of the House Committee on Education and the Workforce. He has received more than $122,000 from Sallie Mae since 1989. In the early 1990s, Sallie Mae relied on its Republican friends in Congress to help overcome its greatest threat: a Direct Lending program that would deprive Sallie Mae of the FFELP loans that had become its lifeblood. In 1993, President Bill Clinton approved legislation that created the Direct Loan Program, low-interest loans made by the US Department of Education that were proven to be more cost-effective than FFELP. In the first two years after the creation of Direct Loans, Sallie Mae shed more than 50 percent of its market value. In response, Sallie Mae spent millions of dollars lobbying Congress to starve the Direct Loan Program. Sure enough, by 2006, Direct Loans accounted for just 19 percent of the market, from a high of 34 percent.
There are signs that Sallie Mae's heyday may be behind it. The financial crisis of 2007 hit the company hard. Then the Health Care and Reconciliation Act of 2010 completely eliminated the FFELP, which accounted for roughly 87 percent of Sallie Mae's portfolio. In response, Sallie Mae laid off 2,500 employees earlier this year.
However, Sallie Mae was selected by the government as a servicer and collector for Direct Loans. It also can still make private loans, which, like federal loans, are difficult to discharge in bankruptcy, but lack the same flexible repayment options. In addition, the company's status as both a lender and a collector of government loans has led some critics to contend that Sallie Mae has incentives to make risky loans — especially since defaults are profitable.
A 2002 report by the Government Accountability Office showed that lenders made more money when they forced a student into default than when they let that student linger in delinquency. In 2003, Sallie Mae CEO Albert Lord told shareholders that the company's record profits were attributable to penalties and fees from defaulted loans. Between 2000 and 2005, its loan portfolio increased only 82 percent, but its income from fees increased 228 percent.
Patricia Christel, a spokesperson for Sallie Mae, refutes that notion. She said that the lending company works with students to find repayment options. "Sallie Mae has a strong track record of helping student loan customers avoid default and preserve or rebuild their good credit, which in turn helps Americans access lower-cost credit in the future, taxpayers save dollars on federally guaranteed student loans, and colleges retain their eligibility for federal financial aid for students," she wrote in an e-mail. She pointed out that in the last twelve months, Sallie Mae has helped "two million customers resolve their past-due accounts and avoid default on $38 billion in federal and private student loans," and that 422,000 borrowers had fully repaid their loans in the last year.
Yet there's evidence that deception and collusion spans from colleges to lenders to collection agencies, and even to the agencies that are supposed to oversee them. In 2007, New York Attorney General Andrew Cuomo brought suit against nearly one hundred schools for giving lending agencies "preferred lender" status in return for bribes, and for allowing lending agencies to put their own employees in school financial aid advice centers. That same year, Secretary of Education Margaret Spellings testified before Congress responding to criticism that the Department of Education failed to clamp down on the practice of student loan companies offering bribes to financial aid officers in return for preferred lender status. Spellings was also asked why, despite a report that the Department of Education had overpaid the lender Nelnet $278 million in subsidies, she never attempted to recollect the money. In an article in The New York Times, a spokesman for the US Department of Justice called the Department of Education's "oversight failures" "monumental."
Such oversights aren't so surprising considering that the Department of Education has had, and still has, ties with executives in the student loan industry. A 2003 US News & World Report article detailed how the Bush administration appointed a number of lobbyists and executives from the student lending industry to positions within the Department of Education, among them Theresa Shaw, who worked in the student lending industry for 22 years. Congressman Boehner once told a group of student loan executives, "I hold you in my trusted hands" before working to weaken a Direct Lending program that government agencies had found to be more efficient than FFELP, according to the book The Student Loan Scam by Alan Collinge.
Meanwhile, consumer protections for student loans have slowly been eroded by Congress, and lenders have expanded their collection powers. For example, Congress exempted EdFund, the nation's second largest provider of student loan guarantee services, from the Fair Debt Collection Practices Act and the Truth in Lending Act. Congress also removed the statute of limitations on student loans, exempted them from the Truth in Lending Act, and removed bankruptcy protections from all loans — unless the debtor can prove that repayment would cause "undue hardship."
As a result, the default rate on student loans has grown tremendously. A loan in default is one that hasn't been paid in 270 days, which allows lenders to tack on additional costs. But accurate data for the number of such loans outstanding is hard to come by because the Department of Education, which tracks the figure, only looks at a brief window of time when assessing whether or not a student has defaulted.
For example, for borrowers who began repayment in the 2008 fiscal year, 7 percent had defaulted by the 2010 fiscal year. But that number is likely misleading considering the six-month grace period and the fact that it takes nine months on average for a loan to fall into default. An article this year in the Chronicle of Higher Education used previously unpublished data to show that, of borrowers who began repayment on their loans in 1995, 20 percent defaulted on them by fiscal year 2010. Collinge, who is a debtor himself and founded the web site StudentLoanJustice.Org, believes the lifetime default rate could be even higher.
"I think the number of lifetime defaults could easily be anywhere between one in four and one in three," said the author. "And that's not even counting all the borrowers who are just on the other side of default."
Borrowers have little escape from debt short of changing their identity, fleeing the country, or dying. "The student loan is an inescapable and profitable debt instrument unlike any other," Collinge writes.
In 2005, Thomas Keith borrowed $46,000 from a private lender to attend the Culinary Academy of California, a for-profit school based in San Francisco. Keith says that his lender, Stillwater National Bank, promised him a fixed interest rate of 9 percent. Upon graduation, however, he found that he was paying an interest rate of double that, 18 percent. He made his first payment of $1,100, but found that the payment didn't touch his principal. In fact, his balance increased by $300.
On worker's compensation from a neck injury, Keith put his loans into forbearance twice before Sallie Mae — which had purchased his loans midway through college — denied him any more forbearances. By then his loan had swollen to $60,000. Now, three years later, it's $120,000. And because Keith's loans are all held by Sallie Mae, he can't get them refinanced by another bank.
"They all refused," said Keith, whose story will be featured in the soon-to-be-released film Default: The Student Loan Documentary. "They said it would be illegal. They said Sallie Mae owns me."
For-profit colleges have been some of the most heavily criticized participants in the student loan machine. Their funding comes nearly entirely from federally backed student loans, but their graduates have the most difficulty repaying. According to the Chronicle of Higher Education, students at for-profit colleges defaulted at a rate of almost 40 percent in a fifteen-year period, twice the national average. In Arizona, 70 percent of defaulted loans are held by students who attended the University of Phoenix, one of the largest for-profit schools in the nation.
Private loans are now the fastest growing segment of the student lending industry at 15 percent of the market. Deanne Loonin, an attorney with the National Consumer Law Center who has testified before Congress on the importance of restoring protections to student borrowers, believes that private student loans, like sub-prime home loans, are predatory. "They have all the characteristics of a predatory loan," she said. "Variable rates, teaser rates, high hidden fees. These are loans that were so expensive and so explosive that borrowers were destined to fail."
That said, the element of personal responsibility should not be downplayed. Just as with any other business decision, a student loan is a choice that should be made only after a student fully understands his or her obligation, and can expect to meet that obligation. That sentiment is often echoed in the comments sections that trail student loan debt stories.
"Welcome to the real world and being an adult!" writes "Mark" in the comments section of a New York Times op-ed story about student loan debt. "What seems to be missing here is ownership by the borrower. Assessing what you pay in tuition and living costs while attending school is just like planning a vacation. You have to figure out what it will cost and if you can afford to do it!"
While such advice seems like a no-brainer, it's also not that simple. For one, many student loans are complex, and often not well-explained to the borrower. Private loans with variable rates also make it difficult for a student to know exactly what he or she will eventually owe. And, as with the case of Kyle McCarthy, unexpected life events can intervene.
"They purposely make it so it's so complicated, so you have no idea what's going on," he said, leafing through bills, envelopes, and no-nonsense warnings. "It's like a spider web, and you're just trapped."
Paying For Life
Well into her third decade of repayment on her student loans, Cynthia Warner gave up. She was living at home with her mom and barely making minimum wage doing various jobs for friends. When her car broke down in 2006, she lost the ability to get to gigs as a background actor, one of the sources of income that had helped her stay afloat. Collections agencies were demanding $900 a month. At 51, the Alameda County native once even contemplated suicide.
Warner's road to debt began when she graduated from UC Berkeley in 1982 with a degree in sociology and $6,000 in debt. She then enrolled in a private, Catholic, evening law school in San Francisco called Kendra Hall, for which she borrowed $8,000 from two private banks through FFELP. According to Warner, she never finished the program because she was "bullied" out of school by a malicious classmate. Two decades, several more loans, and another unsuccessful go at law school later, interest, penalties, and collections fees had swollen Warner's $43,089 principal to $124,651.68.
In 2006, after being harassed by creditors for most of her adult life, Warner filed for Chapter Seven bankruptcy. All of her debts were written off. But her education debt remained.
"They said I couldn't discharge my loans in bankruptcy," Warner recalled. "All my other debts, fine. But not my student loans."
The student loan industry contends that, unlike other borrowers who can hand over their car or house in bankruptcy, student borrowers have no collateral beyond their education — and so therefore to allow bankruptcy discharges would be to invite ruin on themselves. Loan company executives contend that prohibiting bankruptcy discharges allows them to keep their rates low. However, the rates of private student loans climb higher and higher.
While borrowers should not be exempt from their financial obligations, many believe that there are reasons why student loan borrowers should have the same protections as others. "There's no conceivable basis for why student loans should not be dischargeable in bankruptcy," said John Pottow, a professor of Law at University of Michigan Law School who has studied the history of bankruptcy protections for student loans. "It's poor policymaking and it reflects an underrepresented constituency, namely student borrowers, who are far less well-heeled than the student loan industry."
Ultimately, the effect of denying student borrowers a protection guaranteed to most other consumers, is that, when it comes time to clearing the slate, student borrowers are treated more harshly even than someone who, say, drives drunk and kills a pedestrian — a type of debt that could be discharged in bankruptcy.
"The non-discharge-ability of student loans is a moral outrage," said Barmak Nassirian of the American Association of Collegiate Lenders and Registrars. "Seventeen-, eighteen-, nineteen-year-olds, for whom this is way too long-lasting a decision, don't know that when they sign a loan, regardless of what happens to them in life, that piece paper is not a promissory note — it is an instrument of indenture."
Nassirian believes that the exemption creates a system of perverse incentives, where lenders lack the incentive to consider who they lend to, because they are assured of being able to collect. "When you make a loan non-dischargeable, you insulate lenders against any kind economic rationality in terms of should this loan be made," he said. "It reminds you of sub-prime mortgages."
In place of bankruptcy protection, borrowers of federal loans have a number of repayment options. One, known as Income Based Repayment, offers repayment options tied to income level. Another option, called Public Service Loan Forgiveness, offers discharges of federal loans after ten years working in "public service" jobs such as government or nonprofits.
With Income Based Repayment, however, interest still accrues on the principal. In Warner's case, she has already been paying her loans for two decades; if she were to choose the Income Based Repayment plan, she'd be paying off her debt until she was a septuagenarian.
To discharge her debt, Warner had only one option: She would have to file for an adversary proceeding requiring her to prove that repaying her student loans would cause "undue hardship." Congress never specified what constitutes undue hardship, and the standard applied is known as the Brunner test. The first part of the three-part test required her to prove that she could not meet a minimum standard of living if forced to make repayments on her loan. The second part required her to prove that her situation would never improve. The third stipulated that she had to have made "good faith" efforts to repay.
But the process wasn't easy. "I couldn't find a bankruptcy attorney to take my case," said Warner. "They said, 'You'll be paying me to lose.' They said I had no shot."
Warner went ahead with the help of a friend and a book called Bankrupt Your Loans: And Other Discharge Strategies. Unfortunately, the predictions proved true. Warner's case was dismissed this year in a one-page summary judgment. Lawyers working for the Department of Justice argued that Warner failed the third part of the hardship test because the unpaid videography work she had done for five years constituted a bad faith effort to repay her loan.
"Now I'm just waiting for them to come get me," she said. "There's nothing else I can do."
Federal bankruptcy protections seem to be a long way off. Most of the attention lately has been on private loans, whose interest rates are higher and more variable, and whose borrowers have fewer options to get back into good standing when they get into trouble. Student debt counselors typically advise students to exhaust their federal loan options before turning to private loans. Yet as tuition increases, more and more students have to, so advocates for student borrowers have concentrated on private loans, while leaving the status quo for federal loans largely unquestioned. The Oakland-based Institute for College Access and Success, the largest advocate for student borrowers, has made the restoration of bankruptcy for private student loans one of its main focuses, while keeping mostly quiet on the subject of federal bankruptcy protections.
"That's where the most harm may be done to students, because private loan borrowers have no other recourse," said Edie Irons, spokeswoman for the Institute for College Access and Success. "They are completely at the mercy of their lenders. There are no deferments; there are no income-based repayment plans, no loan-forgiveness options. Even if a borrower dies or becomes disabled, or school closes, they or their families will still be on the hook for those loans."
The persistence of loan debt after death is one injustice that may be changing, however. In May, a bill called the Christopher Bryski Student Loan Protection Act was introduced in Congress. If passed, it would increase transparency and disclosure requirements for private loans, and provide for relief if the borrower died.
While it's true that private loans are more dangerous in one sense, private lenders lack the extensive powers of collection that make defaulted federal debt so onerous for borrowers. There is little momentum for this kind of change, though, recently, Sallie Mae has endorsed a restoration of bankruptcy protections for federal student loans — if students have made good-faith efforts to repay them for five to seven years.
But that's not good enough, say some student advocates, who point out that default can happen quickly, and that five to seven years is too long to be forced to wait to receive forgiveness. Further help may end up coming from within their own ranks.
The Future For the Debt-Ridden
Student loan borrowers like Kyle McCarthy, Cindy Warner, and Thomas Keith have begun to mobilize. They are members of the Student Loan Justice network, a grassroots organization and political action committee, which has chapters in major cities across the country. Their efforts are part of a national movement seeking to bring student debtors out of hiding and to begin actively calling for reforms. They lack the financial means that make their opponents — the student lending industry — so difficult to fight. But they have on their side swelling numbers, growing support, and the hope that one day things will be better.
There are signs of change. Student loan advocates agree that the elimination of the FFELP was an important step toward making loans simpler and cheaper for students. Additionally, private, for-profit colleges have come under intense scrutiny of late. Soon, they may have to meet certain requirements for placing graduates in employment in order to continue receiving federal aid. Borrowers with private loans may also see some relief if the Private Student Loan Bankruptcy Fairness Act of 2010 and the Fairness in Lending Act make it through the House and the Senate. Holders of federally issued loans have gotten help as well through recent improvements to the Income Based Repayment program, which have lowered monthly payments and dropped the length of time required before a debt is discharged from 25 years to 20.
In the meantime, however, McCarthy is too frightened to actually see how much he owes. He has to continue working at Borders in order to keep his health insurance, even though his injury flares up at night, giving him pain.
Mostly, he tries to avoid collection agencies. "At this point, I get called every single day," he said. "I don't even know where they're coming from. I don't even know how much I owe, because the emotional stress is so unbearable. Obviously I don't have seventy or eighty grand. And it's just — it's just crazy. To even think about it makes me feel horrible. That's not why I went to school."
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