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Student Loan Bubble Data

posted by Alan White

The New York Fed has posted a new analysis of student loan debt.  Depending on how you read the data, student loan borrowers are either in serious trouble, or are no worse off than consumers with credit card debt or car loans.  The bad news is that only 39% of borrowers are paying down their student loan debt. The rest are either in deferment, income-based repayment (which permits paying less than the interest coming due), or default.  On the other hand, only 14% of borrowers are contractually delinquent in payments. The NY Fed bloggers have yet another way to slice the delinquency data: of those borrowers who appear to be in repayment, rather than in deferment or income-based repayment, about 27% are delinquent.

As for the total debt, it grew to $870 billion as of September 30, exceeding total credit card debt and exceeding total auto loan debt.  The median loan amount is $12,800, which does not seem so unmanageable, but the average is $23,300, meaning a small percentage of borrowers have large amounts of debt. Borrowers like the law students we worry about, with $100,000 of debt or more, are a very small percentage of the student loan population, about 3% of borrowers.  On the other hand, many of those with small balances are college drop-outs, who also struggle.

The bubble aspects of student loan debt are suggested by two statistics.  First, 40% of all borrowers are under 30, and they hold 33% of all the debt and 25% of past due loans.  Given that this group includes every student who has just signed up for her first loan, the future of student loan debt is clearly worrisome.

Second is the 39% figure mentioned earlier; 61% of borrowers are in deferment or income-based repayment paying less than the interest coming due each month. 

So, how many student loan borrowers and how many student loan dollars are in income-contingent repayment and in negative amortization, i.e. the student loan equivalent of Option ARM's? (Actually, not quite equivalent, because unlike neg. am. mortgages, neg. am. student loans are paid off by taxpayers after 25 years, not by borrowers.) The NY Fed data cannot distinguish borrowers in income-contingent repayment from those who aren't repaying because they are still in school.  After some fruitless googling at the Education Department, CBO and think tank web pages I can't seem to find the answer to this obviously important question.  Readers?


That 47% (nearly half!) of borrowers in repayment who are not amortizing their loans represent a huge tax time bomb. The amount of debt forgiven at the end of the repayment period under many IBR and "pay as you earn" repayment plans (but not the ones based on working in public service jobs and the like) is taxable income in the year it is forgiven. So, many of these borrowers face a five or six figure tax bill hitting around age 45-50, which will wipe out any assets and retirement savings they have been able to accumulate -- if they can afford to pay it at all. And the tax liability isn't easy to discharge in BK either.

The percentage of borrowers in this situation is only likely to increase as universities -- and the government -- are pitching broader access to IBR and PAYE as the solution to the problem. Although information about tax consequences can be found at some places students are likely to look (see http://www.finaid.org/loans/forgivenesstaxability.phtml), some government sites touting IBR/PAYE do not disclose it at all (such as http://www.whitehouse.gov/the-press-office/2011/10/25/we-cant-wait-obama-administration-lower-student-loan-payments-millions-b), and the universities themselves don't go out of their way to explain it either.

The tax bomb is particularly vicious because the borrowers who are incurring the most negative amortization, and therefore INCREASING the amount of their forgiveness tax liability over time, are precisely those with lower post-graduation incomes, i.e. the ones least able to afford to pay the taxman when he comes knocking.

Frank, I disagree with the idea IBR is a "tax time bomb." Those that are eligible for IBR, and are not paying back a good chunk of student loans, are probably not amassing substantial assets.

The only income they would have to recognize from forgiveness is the difference between their assets and debts after forgiveness. So a 5 figure tax bill, $10k minimum and assuming otherwise proper withholding, would require someone in the 25% tax bracket to have $40k forgiven and more than $40k in assets over liabilities after forgiveness.

Now a 6 figure tax bill, again not including ordinary income taxes, would require at least $252,525 in forgiven debt for someone in the 39.6% tax bracket. They'd also need $252,525 in assets exceeding debts after forgiveness for all of that to be included as income.

Now the average debt is $23,300 and median is far lower, so that scenario is already unlikely. For those above $40k student loan debt, it's going to be even harder to amass assets.

I think what you are saying, Ken, is that borrowers may be able to utilize insolvency exceptions to COD income. So, in other words, if you are an IBR borrower, do everything you can to keep your net worth zero or negative. Pay rent; don't buy a house. Don't try to save anything for a rainy day. Grandma died and left you a couple thou? Give it away, I guess. If that works.

That's a brutal choice to place on young families. If you want to argue that people benefiting from IBR "shouldn't" be able to accumulate any assets, either for mathematical or moral reasons, OK I suppose, but let's be up front to students that we are asking them to commit to twenty years of paycheck-to-paycheck living. Maybe not quite, but only the finance majors will be able to figure out how much they can save and still be safe from the taxman.

Lastly, doesn't the IRS take the position that it is the taxpayer's burden to prove their insolvency and get out of COD income? If we really believe there isn't a pot of gold for the IRS at the end of the IBR rainbow, then why not eliminate the fear and uncertainty and just say this forgiveness is not taxable?

The credit bureau (the data source at issue here) has no way of knowing who is in deferment and who is in forbearance. In-school status is totally different from in-school deferment. Most deferments surprisingly are educationally-related (people returning to school after a stop-out, a drop-out or graduation with a previous certificate or degree), rather than unemployment deferment or economic deferment, which are rare -- indicated a lack of understanding of their options by those few borrowers who are struggling. Furthermore, the analyst is combining delinquency and default which are very different and cannot be summed, particularly if a bunch of stuff is removed from the denominator.

In-school and grace period should not be included in a delinquency rate calculation, but deferment and forbearance should, as the borrower has entered repayment and is at risk for delinquency. While a strained argument could be make to exclude deferment and forbearance from the delinquency rate calculation, no argument could be made to exclude $0 payment ICR and $0 payment IBR, which are current repayment under any stretch of the imagination. Anyone who says they are not current repayment is trying to squeeze the square peg of federal student lending into the round hole of consumer credit.

While the “paid as agreed” trade line includes deferment and forbearance, these cannot be broken out using credit bureau data. Furthermore, one cannot impute that a borrower is not paying by noticing that the principal balance is not declining. Payments go to fees and interest before principal, so, in some cases, a borrower may be paying down a backlog of accrued interest without seeing a decline in outstanding principal balance for a few months.

“Given that this group includes every student who has just signed up for her first loan, the future of student loan debt is clearly worrisome.” That is not the case. When part-time students are included, nearly half are receiving their first loan after age 30. And the data disproves the other point. The group struggling the most, again using the credit bureau data, appears to be Gen X. Those under 30 have a lower share of delinquent/defaulted debt than debt overall.

“Second is the 39% figure mentioned earlier; 61% of borrowers are in deferment or income-based repayment paying less than the interest coming due each month.” There is no basis for these figures. About 50% of borrowers (excluding in-school and grace period) are in current repayment. While this is a decline from a few years ago, it is certainly a strong figure. Given the tiny percentage of Stafford borrowers using ICR and IBR, the proportion paying less than accrued interest is, in perspective, a small issue, particularly given the maximum on interest that can capitalize in those repayment plans. There is no valid comparison to Option ARMS. People earn more income over time, particular those with significant postsecondary experience (more than one or two years), and income-driven repayment models seem to work fine in other countries, particularly where the payments are received painlessly through tax withholding and the formula is more generous/progressive than in the USA.

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