Honey, I Grew The Student Loan Default Rate

Defaulting on student debt has never been a good idea. The collection process is intense and one’s credit rating will be utterly ravaged for a very long time. And if that loan came care of the Federal Department of Education, it will never go away.

There are people in the world who advocate not paying their loans on principle. New York Times writer Lee Speigel spawned a lot of conversation, outrage and numerous think pieces with his article about his decision to default on his student loans and “never look back.”

But even Speigel acknowledged his advocacy for this point was more a moral decision than a sound piece of financial advice, noting that the choice to default would leave one’s credit looking like a “war zone.” He also strongly advised that people take out as many credit cards as they could and marry someone with good credit before officially telling the Federal Department of Education (DoE) to get lost.

Which, of course, they won’t do.

“The Department of Education makes it hard for you, and ugly,” Speigel said of his now decades-long relationship with the government agency.

It seems that even educational loan defaults’ biggest advocate believes that defaulting is a huge financial disaster waiting to happen.

In that context, two recent pieces of news are rather disturbing. The first is that student loan default rates continue to spike — and there is no end in sight, nor a full understanding of why it’s happening. The second is that recent policy changes out of the DoE have made the prospect of a default considerably more expensive for some borrowers.

Bad news in student lending is potentially bad news for the rest of the economy, since 44 percent of the workforce’s largest cohort has student debt — and is having a tough time digging their way out of it.

Unfortunately, this problem is only going to get a lot more difficult.

The Inclining Numbers

For the last year or so, the DoE reports a rather grim picture of student loan defaults. As of January of 2016, 43 percent of borrowers were behind in their payments, or had stopped making them at all.

According to data put out by the Consumer Federation of America (CFA) earlier this month (extrapolated from data out of the DoE), 1.1 million new loans went into default last year. That brings the total value of federal loans originated by financial institutions (FFEL) and the U.S. Department of Education in default at $137.4 billion — a 14 percent increase from 2015.

“Despite a rising stock market and falling unemployment [rate], student loan borrowers are still struggling,” said Rohit Chopra, a senior fellow at CFA and a former student loan ombudsman at the Consumer Financial Protection Bureau. “The economy remains very difficult for so many young people just starting out.”

Nearly half of the outstanding debt in default comes from the old bank-based federal lending program, known as the FFEL Program. Though borrowers have declined, the FFEL Program carries high fees when borrowers default — up to 16 percent of the principal and accrued interest owed on the loans.

Borrowers used to have 60 days after entering into default (270 days without a payment) to enter into a loan rehabilitation program to avoid the fees. These days, however, it looks like the DoE is being a little less forgiving.

Immediate Fees

That 60-day grace period on FFEL fees seems to be a thing of the past. The DoE recently sent out a set of policy guideline clarifications that imply that borrowers will be burdened with those 16 percent fees as soon as they go into default, whether or not they enroll in a loan rehabilitation program.

“The extra couple months borrowers had to avoid the hefty default fee on federal loans are now gone,” Andrew Weber, a certified student loan counselor, told CBS. “And the fees will hit immediately at the time of default (270 days) instead of several months after the default.”

Consumer advocates — like those at the CFA — note that the situation is essentially unfair to borrowers who often do not know their loans are in default until they see the carnage on their credit report, due to servicing errors at financial firms.

“Federal loans typically enter a default status when borrowers are 270 days late on their payments,” noted the CFA. “Due to servicing mistakes, many borrowers may be learning about problems with their loan for the first time. These agencies are entitled to ‘reasonable’ collection costs under existing law, but hefty fees were considered inappropriate for borrowers who promptly seek to address their default.”

Weber had no comment on fairness, but did note that consumers “will likely have to contend with a much larger balance that now literally grows overnight when they default on federal loans,” which might push some borrowers, who would have attempted a turn-around, away entirely and into more dedicated default.

Millennial Troubles

About 44 percent of millennials hold student debt — or about 33 million people. The average debt per millennial is estimated at $25,000 a person. Quick back-of-the-envelope math indicates that about $825 billion of the $1.3 trillion in student debt owed in the United States — 63 percent — is on the backs of those millennial borrowers.

And as those student loans are spiking in defaults — which are getting more expensive and happening at a faster rate — many may find themselves digging a deeper hole.

It is the latest bit of somewhat worrisome data to go along with generation Snapchat — along with the news that 54 percent of them are underbanked at present and 55 percent say that the money they already owe (student loans primarily) is preventing them from saving money to purchase a home.

Millennials are also currently the largest generation represented in the workforce, so it is no longer accurate to say they are the future of the commerce economy or financial services. They are, more accurately, the present.

But they are an uncertain present with lots of headwinds. Which means the challenge of building the next generation of financial services products for them is bigger — and, by the data rolling out — getting bigger and more pointed each day.