How American Student Loans Morphed from a Hand-Up to Hopelessness

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The Federal Student Loan program first began in 1965. It was intended to make student loans accessible to all, to make the American Dream – going to college and earning more money – possible for everyone. A Federal American Student Loans program was supposed to be the great economic and opportunity equalizer… but somewhere along the way, things went awry. Today, student loans are the fastest-growing category of household debt, burying younger generations financially, and leaving them hopeless to achieve the financial milestones of their parents and grandparents, never mind beating them. How did we get here? On this week’s episode of the Finance Explained podcast, we talk the history of the federal student loans program, potential ways forward, and why we haven’t seen student loan forgiveness yet, with The Debt Trap author, Josh Mitchell.

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Key Stats on Student Loans

As a backdrop to the conversation with Josh Mitchell, as well as to help you understand the sheer magnitude of the student loan situation, I wanted to share the latest numbers on the Federal student loan program. Just how much debt and how many people are we actually talking about here?

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Total Student Loans Outstanding

As of the latest Federal Reserve Consumer Credit survey, total household debt amounted to $15 trillion, with student loans representing $1.6 trillion of that total.

The issue? Student loan debt is the fastest-growing category of debt, increasing 10.8% annually since 2003, more than 2.7x faster than household debt overall and far faster than income growth.

Types of Federal Student Loans

There are several different types of student loans offered by the Federal student loan programs, and what is offered has changed over time as well. For a more detailed explanation of these offerings currently, be sure to check out how to prepare for college financially.

The Federal student loan program no longer offers loans through the Federal Family Education Loans (FFEL) program. This program was a “guaranteed” loan program, where private lenders, like banks, made loans to students, which were guaranteed by state or nonprofit guaranty agencies, who are in turn backed by the federal government. If a student defaulted, the federal government ultimately reimburses the lender for the losses.

In 1994, Congress created the federal Direct loan program – effectively cutting out these middle agencies (and all their fees). The US Department of Education issues federal student loans directly to students. Both the Direct loan program and FFEL program ran in parallel for 16 years, both offering Stafford, PLUS and Consolidation loans.

The enticement for students to go Direct instead of securing funding through a private bank? Only Direct loans would be eligible for certain public service forgiveness programs, income-based repayment plans, and most recently, CARES Act student loan relief.

In 2010, President Obama discontinued the FFEL program, so all loans issued after 2010 are Direct, but $239 billion in Federal Family Education Loans remain outstanding.

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How Many People Have Student Loan Debt

As of Q2 2021, there are 45.4 million federal student loan borrowers who have borrowed $1.6 trillion.

One interesting thing to note about the federal student loan portfolio is how the debt portfolio breaks down by size, particularly as we start to consider and evaluate things like student loan forgiveness.

Currently, 37% of the total American student loans portfolio balance represents debt balances over $100,000… but that only accounts for 7% of all borrowers. When you consider blanket student loan forgiveness, this is one of the inequalities to be grappled with – that the biggest benefits go to a small number of people, many of whom may, given their sizeable debt balances, have high income now.

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Financial Health of American Student Loan Borrowers

This leads me to some metrics on the financial health of American student loan borrowers overall.

Currently, based on reports by Federal student loan servicers, only 1% of student loans are currently in repayment status. The rest are either in forbearance (77%), extended to all Direct student loan borrowers under the CARES Act and since extended through January 31, 2022, are to people currently in-school (10%) or in the post-graduation grace period (2%), or in some type of deferment (10%).

Come the end of January, that is a massive financial shift for many borrowers to face. And it’s not as though we have seen a significant payment of balances over the last 18 months while forbearance and 0% interest was in place for student loans. Balances have increased by $77 billion since Q1 2020.

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Second, past Consumer Surveys by the Fed have shown that consumers with negative net worth, are more likely to have a disproportionate amount of student loan debt. Remember, going to college and federal student loans are supposed to create economic opportunity and bridge financial inequality – this seems like it instead is doing the opposite.

And finally, while delinquencies have effectively been made good during this CARES Act respite for student loans, pre-2020, severe delinquency rates on student loans were double-digits, higher than delinquencies on mortgages at the peak of the housing financial crisis. Delinquencies can be devastating to personal credit scores, impacting family’s abilities to get a mortgage, start a business, and in some cases, even impacting job opportunities.

4 American Student Loans Servicers Quit in Last Year

Another interesting piece of the student loan story is that of student loan services. While the Federal government now issues student loans directly, it outsources the actual servicing – everything from the payment processing to accounting – to third-party servicers. These servicers get paid a fee for servicing student loans.

At the end of September, Navient, formerly known as Sallie Mae, announced it would transfer the loans it services to a new servicer. This is not huge new by itself, except that it marks the fourth such announcement by a major federal student loan servicer in the last year.

FedLoan Servicing, also know has PHEAA, or the Pennsylvania Higher Education Assistance Agency, previously announced this summer that it would not renew its 12 year old contract to service student loans. Its current contract expires in December 2021.

Why are all the servicers jumping ship? Likely because they are about to face a whole host of headaches in the form of higher regulation on top of the need to perform higher cost services, like delinquency collection, when 77% of all student loans now currently in forbearance are required to begin repayment again in just a few short months. My best guess is they aren’t interested in the additional regulation for the service fees being paid.

But know that nearly half of all loan balances and over 40% of student loan borrowers will soon be getting serviced by a new servicer. Be sure to keep careful tabs on your payments, any notices from your servicers, and download your most recent statements before any transitions take place.

The Debt Trap by Josh Mitchell

Armed with the background data, let’s take a deep dive into student loans with Josh Mitchell, WSJ reporter and author of the FFM Book Club pick for Q4 2021, The Debt Trap.

We cover the history of the student loan industry, the shocking reason we got ourselves into this mess of massive student loan debt and soaring college tuition, who bears the most responsibility, his recommendations for how we fix it, and his take on the current administration’s outlook for student loan forgiveness.

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