The Massive Scam of Income Based Repayment

CNBCIn response to this article on CNBC today:

https://www.cnbc.com/2018/11/07/rehabilitation-gives-student-loan-borrowers-a-second-chance-at-a-cost.html

Let’s review a few of the important points of our main character, Scott:

1.) Scott graduated with $35,000 in total debt. OK! NOT BAD.

2.) Scott made payments for 10 years, but the balance went up to $55k. NOT GREAT, BOB.

3.) Scott couldn’t make payments for a while, then “rehabilitated” his loan. MAKES SENSE.

4.) Scott now pays $6,300 a year, the balance is going UP every month, owes $130k, and declared bankruptcy which will not help his loan situation at all. WTF!

This story highlights the massive scam of income based repayment. We’ve looked at this problem before:

https://graduatefree.com/2014/11/21/income-based-repayment-and-debt-forgiveness/

and

https://graduatefree.com/2015/09/16/is-the-public-service-loan-forgiveness-plan-a-good-idea/

In that last linked article I said:

These plans often have payments lower than the interest accruing, so the balance on your student loans can actually GO UP over time. This essentially makes you dependent on loan forgiveness as your only way out of debt.

This was one reason why these student loans reminded me of the “negative amortization loans” of the mortgage meltdown.

Even if Scott gets his loans forgiven, he will have paid many multiples of his original borrowed amount ($6k a year x 10 or 20 years, plus the payments he made for 10 years, plus the income tax hit). And again, there isn’t any way out. If you default, the government will withhold basic social safety nets designed for the poor.

This is the payday lending industry re-imagined.

This is indentured servitude.

Please be careful out there.

 

#TheAdultStudent

hands-girl-vintage-student.jpgOne thing we’ve noticed is that grad students are often bifurcated into students recently out of undergrad (in their early/mid 20’s) and second career students that are typically 15-20 years older. This is one reason the average age of a Denver Seminary student is 32 years old.

This segment of “Adult Students” is getting more attention then they have in the past, including an article in the Wall Street Journal, for a couple of reasons:

  • We’ve documented that older students are more vulnerable to high levels of student loan debt: Students over 31 years of age are significantly (almost 3x) more likely to borrow high levels of debt (over $50k)
  • It’s a larger pool then we thought: Some 41% of students enrolled in higher education are 25 or older.
  • 38% of these older students drop out in their first year. Students that borrow money then fail to earn their degree are among the biggest fatalities of the student loan programs.

Goldie Blumenstyk is a leading voice in this area. A couple of her resources to highlight:

Competent

Jordan PetersonJordan Peterson is having “a moment”. A widely circulated interview brought his considerable platform into the spotlight with a variety of articles including this David Brooks piece which summarizes things nicely.

In the aforementioned interview, he uses a word I hadn’t fully considered: Competent.

“Competency is power”

I bounced that idea off my kids around the dinner table last night. I do want them to marry someone who is competent. Competent at cleaning the kitchen, competent at raising children, competent at balancing a checkbook, competent at managing conflict in a healthy way, competent at managing the many problems life brings.

When my wife and I started dating, my roommate and I were not competent at lots of things, not the least of which was cleaning. We once went an entire year without cleaning the kitchen. Don’t ask. The bathroom was worse, so it took most of the attention away from the kitchen. People would just leave rather then use the bathroom.

We aren’t born competent. We have to learn, and most learning comes from Someone who already knows how to do it.

It’s ok if we aren’t competent in our personal finances yet. It’s not ok for us to stay that way. We, our (future) spouse, our business partners, our children, and our parents deserve better. Have you ever had a friend (usually when you were younger) that always was asking to borrow money? It’s hard to be friends with that guy.

It’s important to develop competencies at:

No judgement. I doesn’t matter when we find ourselves today. I’m much better at cleaning my kitchen these days. Let’s pick one area, talk to someone who knows that area, and start making small actions.

You and I have the capacity to be financially competent.

Extra Income in 2018

1000 extra in 2018Creating a little extra margin in our financial lives will radically change our relationship with money. Saving or earning an extra $1,000 would make a big difference in all of our lives. We can do it in 2018.

A spark of Hope let’s us Believe it’s possible. A little Belief starts our brains looking for Opportunities. An Opportunity seized creates an Action. Action leads to the physical changing of our circumstances.

Changing our physical conditions is “work” in all its forms. The work of creating order from chaos. “All hard work brings a profit, but mere talk leads only to poverty.

Here is an article link to get your brain working and create some hope. Hope in this case being the persistent belief that its possible to change our physical circumstances through “work”.

ARTICLE LINK: 101 Ways to Make $1,000

 

Student Loan Reform in Future?

forbesAn article passed along to me this week with a lead that caught my attention:

A growing number of student loan borrowers — nearly one in three — aren’t making headway in paying down their loans five years after leaving school.

A couple of brief observations:

1.) 2/3 Borrowers with more then $50k in debt aren’t paying down their balances. It’s ‘compound interest’ in reverse – if you owe a lot, the minimum payments just barely – or in some cases don’t – cover the accruing interest. I noted this has a striking similarity to Negative Amortization Mortgages that contributed to the financial meltdown a decade ago.

2.) One of my major concerns two years ago was that the government could change it’s rules anytime on loan forgiveness. This article mentions several proposals that are on the table to do just that including eliminating the Public Service Loan Forgiveness plan altogether. It’s one of the main reasons I don’t think using any version of the loan forgiveness plan should ever be your primary payoff strategy.

3.) We’ve noted before about how the government makes over $50 Billion in profit from the student loan program each year. That enormous cash cow for those in power is the primary reason I don’t predict significant student loan reform for the benefit of the borrowers. In fact, this article says the proposed reforms will earn the government an additional $104 Billion over the next ten years. Incredible.

4.) If the government was actually serious about reform for the benefit of the American citizen, there are a number of options. For example they could put a hard cap on total student borrowing at the median household income ($55,775 in 2017), limit borrowing to the cost of tuition, or financially involve the educational institutions.

Alternative path to wealth

Dollar signLast week I teased that aside from hoping to strike it rich with a miracle investment, there was a better route to go. Here is my brilliant three-step plan:

One: Earn More

Dave Ramsey teaches that your most important wealth building tool is your income. To build wealth, you need to generate income. Saving money (income minus expenses) and investing (return on saved money) are impossible without generating income. Obviously more income increases your chances (but certainly doesn’t guarantee) of having a surplus. If we aren’t currently generating a surplus, we need to either (or both) cut expenses and/or generate more income. Here is some advice on generating more income.

Two: Get rid of Debt

Getting out of debt accomplishes two super important things. First, you take over control of your income. Debt is a lien against your future income. Take control of your future income – it will allow you to save which is step one in accumulate wealth. Second, if you are paying interest on debt, you can have a guaranteed return on an investment by keeping that interest for yourself. See this.

Three: Save cash

This seems counter intuitive, but having a large cash reserve is valuable for several reasons. First, you can negotiate significant discounts on things you are forced to buy. Second, you are prepared when assets that we know and understand become significantly discounted. Like when we get our next recession.  There is a lot more to be said about the advantages of liquidity, but I recommend trying it to see how it feels.

 

Concession from last week. While I’m steadfast that we should let go of the myth of being a great investor, it’s really important to understand that yielding a couple of extra percent yields a massive difference in returns over time. Over 20 years, the difference between earning 6% and 12% on an investment isn’t 2x the return, it’s 3x. This goes up even more over time and/or return.

The Myth of Investing to Wealth

WarrenOur country loves the “Horatio Alger” story – the old rags to riches. In our culture, one of the most popular narratives to riches is through being a great investor.* If I can figure out the market, I’ll be able to see something others don’t and it will make me wealthy. Warren Buffett is the hero of this story. I poured through his biography (The Snowball, 832 pages!) when it came out looking for secrets and clues. One potentially controversial belief I’ve developed:

I don’t believe being a “great investor” is a reasonable path to wealth.

We need to let go of the myth that we are one hot stock tip away from financial success. This narrative is baked into our entire culture. TV networks like CNBC and Fox Business are built on this myth (Here is the 8 best TV shows ranked by a website dedicated to investors). Entire print industries (Money magazine, financial help books) have this narrative intertwined in their unspoken promise to the reader.

I’m convinced it doesn’t work and in fact it’s a massive waste of time and distraction from actually accumulating wealth. Why? Here are three of many reasons:

  • Not enough initial capital

A friend of mine recent came and asked for some advice on which stock to buy with a $1,000. I didn’t have the courage to tell them it didn’t matter. Warren Buffett, the wealthiest person in America and perhaps the best investor in our history has earned around 20% compounded return. Maybe you’re a better investor then Warren Buffett, but if you’re as good as him in 10 years your $1,000 will be worth $7,268.

The point is that most of us don’t have enough upfront capital to take advantage of outsized returns, even if we were to get them. Does this mean we shouldn’t save or make wise investments? Of course not. It should pop the bubble that I’m only one key investment away from financial freedom.

There is a huge separation between how it feels for my $1,000 to be up (or God forbid down) 8 points this morning and the actual impact that will have on my life. That’s why some of the best investors don’t follow the market or invest in individual stocks. That’s why it “doesn’t matter”. There are a dozen other more important financial decisions each month that will affect my financial future far more than the short term fluctuations a $1,000 investment.

  • Have to live on the returns

My dad went to a three-day seminar on how to use stock shorts and options to make a killing in the market. One major problem (beside the fact that nobody actually “beat’s the market”) is that if my dad did this from home he’d still have to pay for his regular living expense from his earnings. For example, if he earned 20% on a huge sum of money like $250k, he would clear about $50,000 in income before taxes. The problem is that he’d use most of that money up, you know, eating and stuff.  It would make it almost impossible to actually accumulate wealth unless you had your living expenses covered by an actual income or you had some amount of money large enough ($2M+) that $50k wasn’t a significant deduction from returns.

Another example. People have asked me about real estate investing. I think it’s a wonderful investment, but unless you have a significant amount of capital don’t plan on making a living doing it for many years. It’s a great side job, but if you’re living on the returns it’s a poor way to accumulate wealth. In fact, almost everyone I know that has done well in real estate has done it by working (improving, changing use, managing, etc.) rather then passive investing.

  • Not really an expert

This one hurts a little. My pride tends to try to convince me that I know more then I really do. I’ve noticed that the professional investors from books like The Big Short and The Snowball spend a tremendous amount of time and attention learning their craft inside and out. I know several professional investors personally, and I’m continually taken aback by how much they put into understanding each investment. Even after exhaustive consideration, they build investment models around the inherent acknowledgement that they will be wrong some of the time.

If someone says you should invest in such-and-such because the kids are using it or something, I beg you to stay away. Virtually all public information is trash. One of the core tenants of all investing is “Invest in what you know”. Being honest about what I really know isn’t easy, but it will save me a lot of dashed expectations and refocus me back on activities that pay huge dividends.

 

Next week: If you aren’t going to waste time/effort/dashed expectations chasing the next great investing tip, what should you do instead?

 

*This rags-to-riches through a great investment is woven into our DNA across all cultures. Jesus told a popular parable about this with a twist – investing everything you have to acquire the truest treasure of life.

Order

Benedict Option“If a defining characteristic of the modern world is disorder, then the most fundamental act of resistance is to establish order. If we don’t have internal order, we will be controlled by our human passions and by the powerful outside forces…”

That quote opens Rod Dreher’s discussion on Order – one of the Rules for Living in his latest book The Benedict Option. As I read the book, the intersections of our personal finances and living a counter-cultural life are everywhere. Some obvious (forgoing materialism for simplicity), some subtle.

One common characteristic of people that win with money is that their personal finances are in Order. It doesn’t have to be a fancy system. It doesn’t have to be electronic with spreadsheets and apps. It doesn’t have to be super nerdy with detail down to the last penny. However, people that win with money have their “house in order”. They display what the author of Proverbs called “diligence”.

It might be infinitely practical; I might need to track my spending in writing. Maybe create a file folder for next year’s taxes. Do a simple budget every month. Balance my checkbook. These are all examples of creating a life of order.

It can also be a grand vision of my place in the universe. Dreher highlights three understandings of order:

  • Discovery of The Order, the logos, that God has written into the nature of creation and seeking to live in harmony with it.
  • Realization of natural limits within Creation’s givenness, as opposed to believing that nature is something we can deny or refute, according to our own desires.
  • Disciplining one’s life to live a life to glorify God and help others.

This week, if it is as grand as seeking to live in harmony with the universe or as imminently practical as opening and processing all our mail each week, lets seek a life of order.