Is it Socially Acceptable to Not Pay Your Student Loans?

Tom Gillespie

Why do people loot a store during a revolt?  Is it because they are trying to make a statement or that they are trying to get free stuff?

There is a fine line between order and chaos.  I know as I was in Los Angeles, one block over from the courthouse, when the Rodney King verdict came out in 1992.  For the next week, I was self-imprisoned in my hotel room waiting literally for the smoke to clear.

Our culture is continually changing.  Technology, political events, economic events, and social values have all changed the ways we live. If you are between the ages of 18-45, you never had to worry about getting credit before 2009.  Now, the entire landscape has changed.  The student loan crisis is the next big problem we will have to deal with. It is also impacting the housing recovery.

I believe that in the next two years, after this current election, the real numbers will start to impact many schools and universities throughout the country.  Some think that bankruptcy protection should apply to student loans.  But then everyone would declare bankruptcy. There is no stigma attached to bankruptcy in America today.   Should we just forgive all student loans? How would that work for future generations?  We could socialize higher education like other countries, but our university system as we know it and individual freedoms to pursue whatever major we desire would cease to exist.

Occupy Wall Street is one good recent example of how people, especially young people, are starting to revolt.  The reason they are revolting is because they were offered credit at a young age and thought that if it was offered to them, they could obviously afford it.  They were wrong.  The rise in student loan defaults coupled with a weak economy, too many political promises, and a broken system could lead to a debtor revolution: “occupy everything”.  We now have over one Trillion dollars in student loan debt.  It’s just a number, really.  The more important number is the cohort default rate.

First, let me put something to rest.  Your recovery rates on student debt have less to do with the economy and more to do with educating your students about their credit. Ultimately, you cannot beat the system.  We like to blame everything on a slow economy.  Default rates on student loans have always been high in good times and bad. In fact, a 30 percent default rate on student loans in the 1980s was all too common.  There was no accountability.  The government changed that by putting in tighter regulations over the years but the bar is still way too high.

Today, you can have a cohort default rate of 24 percent and still be considered OK.  Using the economy as a reason for high default rates is like blaming your extra 20 pounds on McDonalds.

Let’s use an example; the average charge-off rate for credit card companies is 2 percent.  Bank cards are charged off at 180 days past due.   The average cohort default rate today on government student loans is 8.8 percent. But that number was manipulated by our government when they reauthorized The Higher Education Opportunity Act (HEOA) in 2008.  New changes in the way cohort default rates are calculated (from 2 years past graduation to 3 years) suggest that default rates are going to skyrocket when the data is published for 2012.

Why are default rates so high?  The easy answer is the job market but, in fact, default rates on student loans were even higher in the 1980s during an economic boom.  In essence, student loans were never looked at in the same way as other types of debt.  Prior to 2008 and the financial crisis, creditors discounted student loans on credit reports and people with student loans in default were given a free pass in obtaining credit.  Even if they had judgments a mortgage company, auto lender, or credit card company put less weight on student loan debt than others. It was simply not looked at in the same way as other debts.

Now, the credit granting landscape is changing and students have subsequently ruined their credit because they took out these loans at a time when they had no concept of how much debt they were incurring and had no prospects for paying it back.  Also, there are several ways of not repaying your loans if you are so inclined.  Recent attempts to keep interest rates from changing may be successful in stemming the tide for some student debtors but even with that potential benefit, there is a freight train coming down the track.

When the new cohort default rates are calculated, the default rates are going to soar.  With 20-30 percent default rates, will it be more socially acceptable not to pay your student loan?  Many colleges and universities will be in danger of losing their loan programs if their default rate exceeds 25 percent and that could lead to a necessary shift in the way students are offered acceptance.  In essence, admission criteria could be more heavily weighted towards the student’s financial abilities to repay their debt or the families’ ability to finance the education.

When the new cohort default rates are calculated for 2012, the 8.8 percent default rate is going to be more like 16 percent.  Why? Because the law re-aged the accounts. Today there are millions of students who are not in default who have not paid anything on their student loan in two years.