How to fix the student loan mess

The impending student-loan crisis proves Edmund Burke had a point: “Those who don’t know history are doomed to repeat it.” Though the economy has not yet recovered from the 2008-2009 mortgage crisis, the federal government has kick-started its next experiment in making something more affordable. This time, instead of homes, the “something” is college. Despite being different major life purchases, it’s irresistibly easy to compare the two.

We all know how the mortgage story goes: Misguided government incentives and inadequate lender underwriting led many borrowers to borrow more than they could afford. When the bad loans couldn’t be repaid, numerous lenders folded, good people lost homes, and our economy to this day still sputters. Fortunately, we still have time to mitigate the unintended consequences of overbearing government involvement in student loans.

Toby Talbot | AP

Toby Talbot | AP

Federal student-lending programs account for roughly 93 percent of all loans in repayment, or $1.17 trillion. This leaves a mere $91 billion, or 7 percent, with private lenders. Granted, the federal government has an essential role in the student loan market, but this lopsided share is problematic to students for a number of reasons.

First, private student loans arguably have the strongest consumer protection: a robust underwriting process that includes an ability-to-repay test. Government loans are subject to the Department of Education lending rules that don’t require such a test.

Second, private student lenders—again unlike the government—are required to provide comprehensive disclosures of terms, conditions, and full life-loan borrowing costs—i.e., at application, approval, and consummation—and to tell students and families about federal aid programs’ terms. In fact, throughout the loan process, private lenders are required to provide 18 different disclosures, three different times.

Third, the federal government is making loans many borrowers cannot repay. Last month, the Wall Street Journal reported that 6.9 million Americans have gone at least one year without making a payment on their federal student loans. This number is up 6 percent, or 400,000 borrowers, since 2014. Though not the same measure, the closest available comparison for private loans is a June report from MeasureOne showing that nearly 98 percent of private student loans are being successfully repaid—putting delinquency rates for private borrowers at their lowest level since before the 2008 crisis. Robust underwriting used by banks, plus strong servicing programs to assist their borrowers throughout the life of the loan, are helping families meet their obligations.

Private student loans too often are incorrectly knocked for costing more and offering fewer “escape valves” if a borrower struggles with repayment. In reality, private lenders offer a number of products, including both fixed-rate and variable-rate loans, with interest rates that compete with and in some cases are lower than federal loan rates. Moreover, while all direct federal loans have origination fees, few private loans do. And, though federal student loans include various deferment options, these loan features may not be important to some student borrowers, who would prefer lower origination fees and a lower interest rate. For such borrowers, the private loan may be a better choice. And, despite the far-reaching language from critics of private loans, in all cases, it is in the private lender’s best interest to do everything in its power to help borrowers repay their loans, including extending grace periods and modifying loans when possible.

Given the increasing number of students who are not repaying their federal loans, it should be clear that now is the time to restructure this market. We should enact two reforms immediately to better protect students and their families from insurmountable debt burdens.

First, the federal government should be held to the same high standards private lenders are by improving consumer disclosures. The Truth in Lending Act (TILA) exists, in part, to ensure consumers are fully aware of repayment obligations for credit products provided in the private market. Under current law, federal student loans are exempt from TILA, including disclosing the Annual Percentage Rate (APR), which accounts for fees and the impact of deferred payments when calculating the cost of credit. Government loans are governed by Department of Education lending rules, which have key differences, including not disclosing the APR. Better disclosures will afford consumers the opportunity to make better choices.

Second, transparency for federal loan-performance data should be increased. Performance information published by the Department of Education on the Direct Loan (DL) program is woefully inadequate and opaque. Since the Treasury Department bears the ultimate responsibility for managing the DL portfolio, it should be charged with providing information related to loan performance and taxpayer risks. Clear and honest reporting to the public is critically important. If federal programs are going to improve, taxpayers and policymakers must understand the problem.

Late last year, USA Today reported that, since 1978, college tuition and fees have gone up by 1,120 percent. Compare that to the price of food which increased 244 percent and medical expenses 601 percent. CBA believes the federal government can best make college more affordable by helping students become better informed, more careful borrowers. By following the private sector’s lead in stepping up loan disclosures and supplying policy makers with better data, the federal government can prove it has learned a thing or two from past mistakes.

Commentary by Richard Hunt, president and CEO of the Consumer Bankers Association (CBA) representing the retail banking industry, including the nation’s largest bank holding companies as well as regional and super community banks. Follow him on Twitter at @cajunbanker.

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