Lifeboat Drill Active Debt Management

Mark KantrowitzPublisher 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. $1,000

B. $11,000

C. $15,858

D. $18,100

E. $20,000

F. $32,479

Debt Grows with Capitalized Interest

Forbearance Duration

Capitalized Interest

Increase in Loan Balance

Increase in Life-of-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 non-recipients ($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 PlanMonthly

Loan Payment

TotalInterest

TotalPayments

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 TermReduction in Size of Monthly Loan

Payment

Increase in TotalLife-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 Life-of-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