Federal student loans made in recent years resemble the toxic subprime mortgage loans that helped cause the Great Recession, new data show.
Rather than paying down their balances after leaving school, borrowers with recent federal student loans are experiencing an increase in debt as they fail to make enough payments to offset the accumulating interest on their loans.
The situation parallels subprime mortgages before the financial crisis, when lenders gave borrowers loans they couldn't afford by allowing them to make payments that didn't actually reduce their balances.
But while borrowers with toxic subprime loans largely defaulted and lost their homes as their lenders recorded losses, borrowers with federal student loans are likely to have their suffering drawn out for years thanks to a stagnant economy in which wages are barely rising, and existing law and Education Department practices that make it nearly impossible for struggling borrowers to discharge their debt in bankruptcy.
The new data are from a paper made public Thursday by the Brookings Institution in Washington that sheds light on the historically opaque federal student loan portfolio by examining borrowers' repayment practices and wages by the type of school they attended.
More than 40 million Americans collectively owe nearly $1.2 trillion on their federal student loans. But the study by Adam Looney, a Treasury Department economist, and Constantine Yannelis, a former Treasury intern who's now a graduate student at Stanford University, is the first to analyze borrowers' debt burdens by linking them to their earnings information from federal tax records.
To be sure, the data is based on a sample of borrowers' files contained in the National Student Loan Data System, an Education Department-run database that experts contend is rife with errors.
Still, some of the paper's findings mirror conventional wisdom and previous research, such as the fact that students at for-profit colleges largely come from low-income households, borrow too much relative to their eventual earnings, and subsequently default on their federal student loans at astronomical rates.
But the paper also includes new information never made public by the Education Department, which oversees the federal student loan program. That information, which includes borrowers' progress in paying down their debt and the rate at which they default five years after leaving school, is likely to inject new life into a debate over whether the federal government is properly serving students and taxpayers.
It also raises fresh questions about the role played by the Education Department's loan servicers, who counsel borrowers on their repayment options and collect their monthly payments. The federal Consumer Financial Protection Bureau is weighing whether to sue one of them, Navient Corp., for allegedly mistreating student loan borrowers. Navient has denied wrongdoing.
"We're engaging in high-risk behavior we hadn't engaged in before," said Barmak Nassirian, director of federal relations and policy analysis at the American Association of State Colleges and Universities. He described the data as "stunning."
Borrowers whose federal student loans came due in 2010, 2011 and 2012 collectively owed more on that debt two years after they first entered repayment, according to the study.
Borrowers' collective loan balances had never before increased in the two years after they entered repayment, according to data dating to 1970. In the 25-year period that ended in 1995, for example, borrowers had generally paid down about 15 percent of their collective balances in the two years after their loans came due.
More than half of borrowers who entered repayment in 2010, 2011 and 2012 saw their loan balances rise two years later. That, too, is a first for the federal student loan program, where for decades a majority of borrowers had paid down at least a portion of their debt in the two years after they were required to make payments.
For borrowers whose bills first came due in 2012, 57 percent of them owed more on their federal student loans by 2014, the study shows. By contrast, less than 40 percent of borrowers who entered repayment from 1996 to 2006 experienced an increase in their balances two years after leaving school.
The paper doesn't explain why borrowers' loan balances are growing at a time when they're supposed to be decreasing. Possible reasons include the increased use of federal plans that allow borrowers to make payments based on their earnings, the heavy use of forbearance plans in which borrowers' required payments are delayed, and rising defaults as students increasingly flocked to questionable for-profit colleges in the wake of the Great Recession but were unable to secure jobs that would enable them to repay their loans.
About half of recent borrowers entered into forbearance plans in the first year their loans were due, according to the paper. These borrowers likely qualified for income-linked repayment plans that would've enabled them to at least make some of their required payments.
"These statistics should concern any reasonable person who remembers the gathering storm of the subprime mortgage debacle," Nassirian said. "We had an educational financing system that generally had operated fairly well on the basis of certain prudent practices that we have increasingly abandoned."
Take for-profit colleges. After abuses surfaced in the late 1980s, Congress cracked down on the sector with more stringent rules that limited their ability to tap federal student aid and led to stronger consumer protections. Of former for-profit college students whose federal student loan payments were first required between 1988 and 1993, more than half had defaulted within the following five years, according to the study.
But as memories of those abuses faded, Congress and the George W. Bush administration chipped away at the restrictions, leading to an eventual explosion in the number of students seeking credentials from for-profit schools.
Now some of the nation's largest for-profits have among the worst student outcomes, according to the study.
For student borrowers who attended schools operating under the DeVry, Capella, Strayer and ITT brand names, and whose loans came due in 2009, they collectively owed more on that debt by 2014. In fact, among all student borrowers who attended for-profit colleges and whose payments were first required in 2009, they owed $1.05 by 2014 for every $1 they owed in 2009, data show.
In other words, they made no progress in paying down their debts. Instead, their situations worsened.
Their default rates are just as worrisome, according to the study. At Kaplan University, 53 percent of students who entered repayment in 2009 had defaulted by 2014. Some 47 percent of students at Ashford University defaulted within five years, while at the University of Phoenix, the figure was 45 percent. At DeVry, 43 percent of student borrowers whose bills came due in 2009 had defaulted by 2014. ITT's share of defaulters was 51 percent.
Their official Education Department-published default rates, which look at the share of borrowers who default within three fiscal years of their loans first coming due, were much lower, sometimes by half as much.
A loan goes into default when a borrower misses nine months of payments. Of all student borrowers whose loans came due in 2009, 28 percent of them had defaulted by 2014. At for-profit colleges, which claim to serve high-risk students who have been shunned by public and nonprofit schools, the five-year default rate was 47 percent.
The Obama administration has introduced a new rule to clean up the for-profit sector by prohibiting federal student aid at wasteful career-training programs where graduates' earnings aren't high enough to reasonably pay down their debts. But the rule does little to address drop-outs, who make up the bulk of student loan defaults.
"These numbers are early-warning signs that we should re-examine our ways," Nassirian said. "We ought to be very concerned that we may have changed some of the most basic features of the entire financing scheme, and should stop consoling ourselves that things will be OK in the future because they've been OK in the past."