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.

 

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.

Loan Forgiveness and PSLF

Tnythis article surfaced in The New York Times a couple weeks ago:

They Thought They Qualified for Student Loan Forgiveness. Years Later, the Government Changes Its Mind.

I’ve written several times including this long post in September of 2015 that I thought the Public Service Loan Forgiveness program was risky and I did not think it was wise to plan on the PSLF program to be your primary loan repayment strategy.

The risk that the government could change the rules at any time was one of the original reasons I wrote that I didn’t like the program. That is exactly what happened to the subjects of that NY Times article and we’ll see how the pending litigation plays out.

There are other alternatives. If you’d like some help working through those then hit me up.

Flexibility: Why Debt Hurts Your Income

ball-and-chainIn addition to my original post on Loan Forgiveness, last week I reviewed the Public Service Loan Forgiveness (PSLF) program.

I wanted to blow out one additional thought on the PSLF – but this really applies to all debt, any government program, and your ability to negotiate a higher salary for the rest of your life.

The value of flexibility

The human brain is really poorly equipped to understand opportunity cost.  Opportunity cost – basically the idea that when you do “A”, you forgo the opportunity to also do “B”. For example, if you are a full time student, you forgo the opportunity to work for that year. It’s hard to compare/contrast the value of a degree and a year of formal education versus a year of income and experience. It’s REALLY hard to evaluate today’s opportunity value over the next 20, 30, 40 years.  For example, if you saved $6,000 in that year and it earned 10% over the next 40 years it would be worth $322,000.  Is that more or less valuable than a year of education?

One of the underrated problems of the Public Service Loan Forgiveness plan is that it lock’s you into one job. While it may seem amazing to have $75,000 of debt forgiven, if you really break it out that’s $840 a month or $10,000 a year (including interest). Is it possible through hard work and diligent looking to find a job or alternative stream of income where you can earn an additional $10k a year? Absolutely.

When you find an additional stream of income or develop a skill that serves the community in a way where they are willing to pay you for it, you own that. It transfers with you into new geographic or employment futures. It’s additional financial flexibility provides leverage in the type of jobs you choose to take.

This commitment to flexibility is why one financial guru dislikes home ownership. James Altucher is a secular, contrarian, pot-stirrer that tries to reshape our financial perspectives. Note the reason for his position against home ownership:

You’re trapped. Lets spell out very clearly why the myth of homeownership became religion in the United States. Its because corporations didn’t want their employees to have many job choices. So they encouraged them to own homes. So they can’t move away and get new jobs. Job salaries is a function of supply and demand. If you can’t move, then your supply of jobs  is low. You can’t argue the reverse, since new adults are always competing with you. (source)

His point (among others in the article) is: the Opportunity Cost of homeownership is that the illiquidity of your house prohibits your ability to take a different job outside a very limited geographic area.

Think about that point in the context of the Public Service Loan Forgiveness plan. If your employer knows you have a large student debt burden does that give you more leverage in salary negotiations? Of course not – they know you need a job. Once you have the job, does it put downward pressure on your future income? Sure – they know you are locked in. If your employer knows you need 120 consecutive payments from a qualified 501c3 or you fall out of the PSLF, does that give them additional leverage?

Your employer shouldn’t have that leverage. Even if they know you could go earn $10k-$20k MORE in the non-501c3 market, if you’ve been in the PSLF for four, five, or six years they are pretty confident you won’t leave.

The first rule of negotiating: Whoever has the most ability to walk-away has the leverage.