Sunday, 29 September 2019

Federal Student Loans: What Happens If You Don't Pay?

Student loan law right now is kind of a mess, to be perfectly honest. There is a lot of student loan debt out there. Total student loan debt right now is around $1.5 trillion. 44 million borrowers have student loans, and upwards of 70% of students graduating from college are graduating in debt. The loan program makes loans to all undergraduates, regardless of the program that they study, regardless of their income background, and regardless of whether or not they are likely to complete their program, and at two-year colleges, at community colleges, and at four-year colleges. It's not surprising that if you don't have any criteria on the front end to screen out people who are unlikely to pay, then you end up default rates that are somewhere around 20% to 25%.

Federal Student Loans: What Happens If You Don't Pay

A four-year graduate would typically leave college with around $30,000 in debt, depending on their circumstances. The federal government doesn't charge you late fees if you miss a payment on your student loan. They will continue to charge you interest on the loan, and if you go long enough without making payments, several months, it can affect your credit score. So, if you start falling behind on your payments, you enter a type of status called "delinquency".

  • For federal student loans, borrowers can miss up to nine payments or essentially be 270 days past due before the loan actually goes into default status. It triggers something called "acceleration" where the full balance of the loan becomes due all at once, and that the gives the federal lenders more opportunities to pursue borrowers. About one in five are in default, and that equates to... It's about 8.3 million people who are in default on a federal student loan.

A 25% default rate, that sounds like a catastrophic number. That is the kind of number you would associate with a severe economic recession. For borrowers who default on federal student loans, the consequences can be pretty severe. For federal student loans that go into collections, federal law allows for massive collections cost and penalties that can be upwards of 25% of the outstanding principal and interest balance, meaning that if you have $40,000 in federal student loans and them into default, that balance can go up to $50,000 as a result of the default. The federal government has additional collections powers that private entities don't have. The federal government can garnish your wages without a court order. They tend to do this as a last resort, but it's actually done quite commonly.

The federal government collects around $600 million a year through wage garnishing on defaulted federal student loans. 

  • It is difficult to discharge student loan debt in bankruptcy because the bankruptcy code was rewritten to largely bar borrowers with student loans from discharging those loans. It requires something called an "adversary proceeding", which is essentially like a trial in bankruptcy court, in order to show that the borrower meets the undue hardship standard. A lot of borrowers are not able to meet that standard.

The reason why Congress prevents you from discharging your loans in bankruptcy is that there is no underwriting on the front end for the loans. So, the government makes loans to anybody and everybody, and so if you combine it with, easy discharge ability for bankruptcy on the back end would be a program that is rife for abuse.

My Opinion

I think that the system is unsustainable. They need to make reforms that allow borrowers, or I should say allow students to go to school without needing to borrow, or at least not needing to borrow as much. I also think that they need to strengthen programs for borrowers that are already in repayment so that they can have an easier time of dealing with their loans without having to wade through a messy servicing and debt collection system. I think people need to be more careful in the amount that they borrow, in the amount that they are going to pay off. 

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