Rising Student Defaults Don't Mean What You Think

Yes, it is true. Student loan defaults are sizable. Recent data show that 7 million individuals are at least one year late in their payments. Before panic sets in and allegations fly about how expensive higher education is, how unsustainable the debt loads are and how likely it is that the student loan bubble will burst, let's think about what the student loan default rates really mean.

There are many options short of default available to college graduates and those who have stopped and dropped out. Think about income-based repayment, public loan forgiveness, deferral and forbearance. And in the future, there will be REPAYE. One critical question to ask is this: If so many options to prevent default exist, why are almost one-fifth of the borrowers defaulting?

There is plenty of blame to go around in terms of that outcome and the information asymmetries leading to it. Let's start with the federal government.

While uptake on income-based repayment has improved recently, it is not as if the performance of Federal Student Aid has been stellar in terms of getting quality, understandable information out on repayment options; and even if shared, the uptake has not been optimal. The options are also way too complicated; that is for sure. More information and added options are not the answer; quality information effectively communicated and fewer but clearer options are preferable.

Then, colleges and universities often do not track the status of their graduates in terms of loan repayments post-graduation. They do not see it as their responsibility, although I think that is something of a misguided view given that if default rates are too high, access to Title IV funds can be affected. And, for the record, the exit interview conducted by colleges and mandated by the government for graduates has not exactly guided folks effectively on how to partake of the myriad of repayment options.

Individuals who owe debt often ignore the warning signs and avoid dealing with their money problems; graduates are not unique in this. Debt is like some health issues; we ignore it "on purpose." We can view this as a failure of personal responsibility to be sure; we can also see it as the natural reaction to unpleasant, difficult and seemingly intractable problems.

What are the solutions? How can we improve the uptake of benefits by those who owe monies to the federal government? Here are three (among many) options:

(1) Change the choice architecture so that students are automatically enrolled in income-based repayment, or REPAYE, or whatever is the best available program for the greatest number of folks. This is an idea that would make Sunstein and Thaler proud. Individuals could then adjust the default choice if there were another option that suited them better;

(2) Make sure that information on repayment (viewed as a back-end issue) is discussed at the front-end, when students are making borrowing decisions. We de-couple borrowing and repayment, and that leads to uninformed decisions. To be sure, better packaging of the information would be beneficial. Also, those doing the counseling likely need more professional development so they understand the repayment options fully as we artificially segment those who do financial aid packaging from those who work on collections in many institutions; and

(3) Place an onus on colleges/universities to work with their graduates to handle their debt more effectively using carrots not sticks. This approach has many benefits, including the possibility that alums will feel a greater connection to their alma mater. It likely means improved tracking of alums, but surely the government has at least some data on its borrowers (and if it does not, it should). And, reward colleges in some way (like increasing work study dollars) if their graduates do not default.

It would be both wrong and naïve to say that the costs of education are irrelevant. That is a topic we should be addressing. But the borrowers who are out there now in the world have already paid for their education and now they need to repay. No matter how much we complain about rising costs, we won't be resolving rising defaults among recent (and not so recent) borrowers.

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