Do you remember political consultant James Carville’s famous line during the 1992 presidential campaign? “It’s the economy, stupid,” Carville supposedly observed. That eloquently simple remark became Bill Clinton’s distilled campaign message and helped propel him into the presidency.
Something similar might be said about the student-loan crisis. “It’s the interest, stupid.” In fact, for many student borrowers, it is the accruing interest on their loans – not the amount they borrowed – which is causing them so much financial distress.
This truth is starkly illustrated in the case of Murray v. Educational Credit Management Corporation (2016), which was decided last December by Judge Dale Somers, a Kansas bankruptcy judge. At the time they filed for bankruptcy, Alan and Catherine Murray owed $311,000 in student-loan debt, even though they had only borrowed about $77,000. Thus 75 percent of their total debt represented interest on their loans, which had accrued over almost 20 years at an annual rate of 9 percent.
As Judge Somers explained in his ruling on the case, the Murrays had taken out 31 student loans back in the 1990s to obtain bachelor’s degrees and master’s degrees. In 1996, when they consolidated their loans, they only owed a total of$77,524.
Over the years, the Murrays made loan payments when they could, which totaled $54,000 – more than half the amount they borrowed. Nevertheless, they entered into several forbearance agreements that allowed them to skip payments; and they also signed up for income-driven repayment plans that reduced the amount of their monthly payments. Meanwhile, interest on their debt continued to accrue. By the time the Murrays filed for bankruptcy in 2014, their $77,000 debt had grown to almost a third of a million dollars.
The Murrays’ combined income was substantial – about $95,000. Educational Credit Management Corporation (ECMC), the creditor in the case, argued that the Murrays had enough discretionary income to make significant loan payments in an income-driven repayment plan. In fact, under such a plan, their monthly loan payments would be less than $1,000 a month.
But Judge Somers disagreed. Interest on the Murrays’ debt was accruing at the rate of$65 a day,Judge Somers pointed out – about $2,000 a month. Clearly, the couple would never pay off their loan under ECMC’s proposed repayment plan. Instead, their debt would grow larger with each passing month.
On the other hand, in Judge Somers’ view, the Murrays had sufficient income to pay off the principle of their loan and still maintain a minimal standard of living. Thus, he crafted a remarkably sensible ruling whereby the interest on the Murrays’ debt was discharged but not the principle. The Murrays are still obligated to pay the $77,000 they borrowed back in the 1990s but the accrued interest – almost a quarter of a million dollars – was forgiven. (The case is now on appeal.)
The Murrays’ case may seem extreme, but in fact, millions of student borrowers are seeing their loan balances grow, not shrink, after they begin the repayment phase of their loans. Why is this happening?
First of all, like the Murrays, millions of student borrowers have obtained various types of forbearances or deferments that allow them to temporarily skip their loan payments. This provides borrowers with temporary relief from their payment obligations, but often the interest on their loans continues to accrue during the period they are not making payments.
In fact, according to a 2015 Brookings Institution report, more than half of a recent cohort of borrowers owed more than they borrowed two years into repayment. Clearly, the government’s various forbearance and deferment plans are causing loan balances to grow for many borrowers, making it more difficult for them to ever pay off their loans.
In addition to deferment and forbearance programs, the U.S. Department of Education offers another alternative for student-loan debtors who are finding it difficult to make their loan payments: income-driven repayment plans (IDRs). These plans allow college borrowers to make monthly payments based on their income, not the amount they borrowed. In return for lower payments, however, borrowers pay on their loans for a longer period of time – 20 or even 25 years.
But IDRs have substantial downsides. For instance, many IDR participants are not making loan payments that are large enough to cover accruing interest. Thus, their loan balances grow larger with each passing month even when borrowers are faithfully making payments. For example, Hayley Schafer, graduated from veterinary school a few years ago owing $312,000 in student loans. Although she landed an entrylevel veterinarian’s job paying $60,000 a year, her salary was not large enough to make monthly payments under the federal government’s standard 10-year repayment plan. Thus, Dr. Schafer opted for a 25-year income-driven repayment plan with monthly loan payments determined by her income. Based on her salary at the time, her payments were only $400 a month. Unfortunately, Dr. Shafer’s monthly payments were not large enough to cover accruing interest. At the end of her 25-year repayment plan, she will likely owe a staggering $650,000!
Moreover, the Internal Revenue Service treats the amount of a forgiven loan as income. So at the end of Dr. Shafer’s 25-year repayment plan, she can expect to receive a tax bill in the neighborhood of $200,000.
Hayley Shafer’s story is exceptional, of course, but many people who sign up for income-driven repayment plans will never pay off their loan balances. In fact, a U.S. Government Accountability Office report released in December estimates that the federal government will only get back about 61 cents on every studentloan dollar that is financed by an IDR.
In addition to negative amortization, there is another significant downside for student borrowers who enter 20-year or 25-year repayment plans – the psychological cost of being indebted for the majority of their working lives. As Kathryn Hancock noted in her column in Law and Psychology Review:
Studies have consistently found that socioeconomic status and debt-to-income ratio are strongly associated with poor mental health. Debt from student loans is often viewed as necessary by most Americans, but can be a chronic strain on an individual’s financial and emotional well-being. The mere thought of having thousands upon thousands of dollars’ worth of debt can severely impact those with already fragile mental health, especially if they will carry that debt for the rest of their lives.
So far, the U.S. Department of Education refuses to acknowledge the psychological cost of putting millions of people into long-term repayment plans. The Department continues to tout these plans as a good solution for college borrowers who find their accumulated student-loan debt to be unmanageable. About 5.6 million people were enrolled in IDRs at the end of 2016, and the Department hopes to have 7 million people in these plans by the end of 2017.
However, a few bankruptcy judges have acknowledged the psychological cost of having long-term student-loan debt. For example, in the 2014 case of Lamento v. U.S. Department of Education, Alethea Lamento, a single mother of two children, attempted to discharge about $72,000 in student loans. At the time of her bankruptcy filing, Lamento was working in a grocery store and had an income so low that she and her children were forced to live with Lamento’s mother.
The Department of Education argued that Lamento should be put in a 25-year income driven repayment plan, but Judge Pat Morgenstern-Clarren disagreed, citing the psychological costs of the Department’s proposal. “Given Alethea’s desperate circumstances, and her status as the proverbial honest but unfortunate debtor,” Judge Morgenstern-Clarren concluded, “she is entitled to sleep at night without these unpayable debts continuing to hang over her head for the next 25 years.”
More than 40 million Americans owe a total of $1.4 trillion in studentloan debt, and millions are struggling to make their monthly loan payments. Deferments, forbearances and incomedriven repayment plans provide shortterm relief for overburdened student borrowers, but in many instances those options cause borrowers’ total loan debt to grow. Indeed, the Wall Street Journal reported recently that more than half the student borrowers at more than 1,000 colleges and schools had not reduced their loan balances by one dime seven years after beginning the repayment phase on their loans.
We have argued repeatedly that distressed college borrowers deserve reasonable access to the bankruptcy courts. We agree with Judge Pat MorgensternClarren that “honest but unfortunate debtor[s]” are entitled to a fresh start and should not be burdened for the rest of their days by student-loan debt they will never pay back.
Obviously, no one wants to allow college graduates who obtained a valuable education to shed their student-loan obligations just as they are about to embark on high-income careers. But the reality for millions of Americans is starkly different. Many borrowed enormous amounts of money to obtain postsecondary education that did not lead to good jobs. Others were unemployed or under employed for a considerable period of time and saw their loan balances grow while their loans were in forbearance or deferment. And more than 5 million student borrowers entered IDRs, with many making monthly payments so low that their loan balances are negatively amortizing.
One thing is certain. The various federal options for distressed college borrowers have provided short-term relief from burdensome monthly loan payments, but that relief has come at a high price. Millions of college borrowers are seeing their loan balances grow larger with each passing month, which means that millions of student loans will never be paid back.
