Student Debt Crisis —Part 2

This is Part Two of a two-part series on the Student Debt Crisis now facing America. In Part One, we looked at how bad the problem really is and how we got here. In this second installment, we’ll look at proposed fixes and how with some good planning you can avoid becoming a student loan debt casualty.

As we covered in Part One last month, the Student Debt Crisis is a major problem for our country. The government’s plan to loan money hand over fist to produce an American workforce that would be “more educated … and competitive” has largely backfired. Former students are saddled with huge student loan debt, and many cannot or will not pay their loans back, which has created a whole new set of problems. These indebted student borrowers become damaged consumers, making it much more difficult for them to contribute to the economy in a meaningful way. A shaky loan payment history means bad credit scores, which can mean not qualifying for that apartment lease, let alone qualifying for that first mortgage. Additionally, many employers run credit checks on prospective employees, so that poor credit score can come into play there as well and may mean not getting that better job – the very one that college degree was supposed to help you get in the first place – a sad irony.

The crisis isn’t lost on the Obama administration and other policy-makers, many of whom helped create the problem in the first place. The Obama Administration has already put forth an array of programs to help borrowers, including slashing monthly bills by tying payments to incomes, and forgiving some of their debt. Often these programs set a borrower’s monthly payment as a share of income, causing payments to typically fall by hundreds of dollars under the plans, known as “income-based repayment”. Some programs waive the loan balance after a certain time period, while others waive the balance if you take on a certain job for a period of time. However, these loan forgiveness schemes ultimately only shift the debt amount to the government’s balance sheet, meaning that taxpayers are the ones who will eventually foot the bill. Enrollment in loan modification and forgiveness plans has skyrocketed recently, jumping 48% over the year to 4.6 million borrowers as of January 1, 2016.

Not everyone agrees, however, that income-based repayment plans are the best alternative for all borrowers. Such plans lower one’s monthly payment, for example, but not the total owed. Education experts also point out that government documents don’t emphasize to borrowers that the income-based plan can increase their overall debt. While income-driven repayment plans can be useful as “a safety net” for those who cannot afford their current monthly payments, experts worry that the plans are being touted too much without enough focus on the downsides.

In addition to examining how the government is trying to fix this student debt loan mess, it’s important to consider what the government could have done. Simply put, the government would have been better off not launching grandiose plans to loan billions of dollars to students and their parents in the first place. Policy makers should have let the markets decide how capital would be deployed to meet the needs of student loan borrowers. Amazingly, the government imposes virtually no credit checks on borrowers, requires no cosigners and doesn’t screen people for their preparedness for college-level course work. This is a system made to fail. Private lenders would have been better at evaluating who should qualify for student loans and at what terms. Borrowing would have been more limited. Additionally the mechanisms enforcing loan repayment were flawed. Some education experts maintain that schools should have some “skin in the game” as well. This could be accomplished by making schools bear some loan repayment responsibility for graduates who can’t find jobs in their field and are unable to make payment by themselves. This might curtail schools from encouraging, for example, a student from borrowing hundreds of thousands of dollars to get an undergraduate degree in Philosophy.

The best way to avoid being part of the Student Debt Crisis is to have a plan in place for the future college or trade school students in your life years in advance. Higher education is expensive, and few think it will get cheaper going forward, so you need to start saving early.

In my opinion, the 529 Plan is hands down the best way to save up for post-secondary educational expenses. A 529 plan is a state sponsored educational savings plan that allows for tax free growth of assets that are set aside for the education of a specific beneficiary. 529 Plan account funds can be used to pay for the educational expenses related to attending qualified institutions nationwide and are not limited to the plan sponsored by your state of residence. For instance, you might be a resident of Georgia and participate in a 529 Plan sponsored by Virginia and your beneficiary could use the funds to attend college in New York. However, your research should begin with your home state’s plans because those plans may have state-specific tax advantages like allowing you to take a credit or deduction against your state income tax obligation.

529 Plan accounts have many benefits over other savings account types. The biggest benefit is probably their preferential tax treatment. While contributions to a 529 plan account aren’t tax-deductible on your federal income tax return, contributed dollars grow tax free while they remain in the plan account. Secondly, distributions for the educational expenses of the named beneficiary go untaxed, meaning the investment gains are never taxed if the money is used specifically for college expenses. In addition, 529 plan account owners enjoy preferential estate tax advantages as well. The money a donor places in a 529 Plan account is not included in the donor’s estate.

Another benefit of 529 Plan accounts is that the donor retains control of the funds. The donor decides how the account is invested, how funds are distributed, and who the money goes to. Sometimes the originally named account beneficiary doesn’t need the money when college rolls around. In instances like this, the donor can change the beneficiary to another qualifying family member, if needed. The donor is also permitted to reclaim the funds for his use if no desirable beneficiary exists. However, there are special income tax consequences that kick in if the funds are used for anything other than educational expenses, so a donor should carefully evaluate all of the possible ramifications first.

Just about anyone is eligible to open a 529 Plan account. There are no income or age restrictions, and a donor may contribute up to $300,000 per beneficiary, so if you want to get started, please research your state’s plans. Next, you’ll want to compare those benefits with plans offered in other states.

Finally, here are some other tips from education experts about how to plan for college expenses:

Do your best to calculate all of your costs in advance. Is your tuition locked in for all 4 years? Are grants and scholarships available? How long is financial aid offered and will it be enough? Don’t forget that college costs are more than just tuition, fees, supplies, and room and board. There are the costs of campus life, entertainment, and transportation (including trips to and from home).

Consider attending a community or junior college first. Tuition at these schools is 50% cheaper on average than the cost of a 4-year college, and assistance is available. Most schools have agreements with 4-year colleges allowing for the transfer of course credits.

Apply for federal aid by completing the FAFSA form, even if you don’t anticipate qualifying. The form is much easier to complete than it used to be, and now can take as little as 20 minutes to complete online. Many applicants are surprised to learn that they qualify for assistance as they were mistaken about the factors taken into account when calculating need. Even if you don’t qualify for aid, your intake information helps educational institutions, the government, and loan providers better understand the makeup and challenges facing today’s applicants.

Pursue your dream education and job, but factor into that hoped-for future the earnings potential of that line of work, and how being saddled with a lot of student debt would impact that future. Sure, you may dream of being a full-time yoga instructor. But even a yogi with $100,000 in student loans can struggle to find her inner peace.

If you borrow, remember to borrow as little as you can, as slow as you can, because you’re never sure what’s going to happen. A good rule of thumb for borrowers is to limit your total student loan debt at graduation to the annual starting salary of your first job.

Get help. High school guidance counselors can be a great resource, but they can struggle to keep up when they are helping hundreds of high school students at one time. Thankfully, there are other resources available, and many of them are online including: www.FAFSA.ed.gov, www.StudentAid.ed.gov, www.FinAid.org, and www.bankrate.com.