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Student Loan Interest Accruing Faster than Garnishment Limits?

posted by Adam Levitin

The New York Times recently ran a very sad, if extreme and unrepresentative, story of student loan debt. There's lots one can say about the article, but two points really jumped out at me. 

First, it's a real problem that the Department of Education cannot refuse to lend on the basis of a borrower's unsustainable debt load.  The DoE should be allowed to refuse to lend to overleveraged consumers, both as a consumer protection matter and as a protection of the public fisc. There's a problem begging for a bipartisan legislative fix. 

Second, by my back of the envelope calculations, the DoE simply cannot collect most of the debt from Ms. Kelly. Let's assume that the only real source of recovery for the DoE is by garnishing Ms. Kelly's income. Her other assets are either legally off-limits to creditors or not valuable enough to go after. As far as I can tell, the maximum garnishment amount will not even cover the interest accruing on the loans. In other words, her loans will negatively amortize even with full-bore collection activity. 

The article didn't report Ms. Kelly's income as a parochial school high school teacher. Let's guess that it's around $50,000 annually and that her annual disposable income is around $39,000.  The most DoE can garnish is 15% of disposable income (basically post-tax).  That would be $5,850/year.  Thus, if Ms. Kelly's $410,000 in debt is accruing interest at much over 1.4% per year, it will continue to grow even while in collection absent voluntary payments.  The interest will accrue faster than the garnishment will reduce the debt. If that isn't a sign that something has gone seriously wrong with a lender-borrower relationship, I don't know what is. (It also makes me wonder if there is some sort of unconscionability argument possible here.)


It might have been better for the writer to have chosen a more representative story. Many borrowers wind up in untenable situations through combinations of recklessness and poor fortune. But that woman's story is almost wholly about recklessness. If anything, a certain portion of the readership might walk away with exaggerated stereotypes. Good article, but strange case study.

A commenter to the NYT story contended that Ms. Kelley should be eligible for Pay As You Earn and could do even better if she got a job qualifying her for Public Service Loan Forgiveness. The commenter used the data in the story to estimate her payment could be as little as $77. I haven't checked his math and don't know whether there are any glitches in that idea including that she is already in major default and in collections.

That being said, I completely agree that there ought to be a point at which DoE has the right to say no. The difficulty is deciding where to draw that line. For example, while it seems obvious that DoE should not be required to lend beyond the point at which the maximum amount it could collect in garnishment would no longer amortize the loan, that amount is dependent on the borrower's projected income. As a result, a future-collectability-based standard for the approval of student loans may heavily subsidize law, MBA, engineering and medical degrees at the expense of humanities, social work and education. In an ideal market, that would force universities to stop charging just about the same for a BA in music theory as a BS in chemistry, or the same for a year of law school as a year of social work grad school. Somehow, I am not sure that would happen.

And, the existence of forgiveness programs further complicates applying a debt cap at the time of loan origination.

"The DoE should be allowed to refuse to lend to overleveraged consumers, both as a consumer protection matter and as a protection of the public fisc."

I assume the concern over the public fisc is based on some notion that the federal government can "run out of money" and go broke, like a household.

This is objectively untrue, as the United States is the monopoly issuers of dollars and therefore cannot run out.

It is important for all citizens concerned with the public policy question of how to use the vast resources of this country to understand how the monetary system actually works, rather than blindly buy into the false "government is like a household" narrative.

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