Flawed Loan System

The methods for repaying student loans are "inconsistent and sometimes irrational" and "highly complex," according to a report that calls for new approaches to borrowing and repaying.

The report, "Addressing Student Loan Repayment Options," is being released by the Project on Student Debt, which studies issues related to borrowing. The new report is the result of a broad review by the project's staff.

Loan repayment has become a crucial issue, the report says, because of the growth of borrowing -- compounded (in some cases literally) by higher interest rates. About two-thirds of college graduates carry debt and their average debt has increased by more than 50 percent over the last decade, even accounting for inflation.

The theory behind borrowing, the report notes, is that college graduates see sufficiently significant income gains because of their educations that the borrowers gain economically, even while facing potentially large debts. And "in general," the report says, there is truth to this model. But a major issue in the study is the extent to which that generality is "both variable and unpredictable" for individual college graduates, who may not realize the hoped for economic gains that make repaying loans feasible.

Both for those who take relatively low-income jobs (many of which perform vital social functions) and those who face unexpected crises, repaying loans can quickly become unmanageable, the report says.

Once again, there is a theory about the system: that there are protections in place for such cases. But the report says that this theory doesn't reflect a reality in which many borrowers "who clearly should qualify for assistance do not," some incentives under the system discourage borrowers from making good choices about their lives, some programs do not adequately consider family size, and those who have low incomes for a long period of time lack help. The report also says that even in cases where good provisions or programs exist, many of the people who might benefit don't know about the help they could receive.

The report offers a number of comparisons that show inequities or oddities in the current system with regard to "protected income," the amount of earnings that are not expected to go to loan repayment. For someone with large debts, the "protected income" is crucial -- that's what he or she lives on. Some examples:

• A full-time worker with $15,000 in loans, earning $12,000 a year, who applies for "economic hardship" relief would not have any protected income. Someone in the same situation but working part time would have all income protected.
• A full-time worker with $79,000 in loans, earning $37,500 a year, and applying for similar relief would receive none. But a person in the same situation, but with $80,000 in loans, have all income protected.
• For a family of four using the "income contingent" repayment option (designed for those with low incomes) would have only $19,350 in protected income. If that same family was having wages garnished, having defaulted on loans, the protected income could rise to $47,940. And a family of four, supported only by minimum wage jobs, would receive no protected income after four years.

The report outlines a range of possible improvements in the loan system -- and also notes that many of the current rules were developed for good reasons, but have been overtaken by events.

The suggested improvements include expanding and easing "economic hardship" provisions so that more people can qualify. This could involve both changing definitions, ending seemingly arbitrary cutoffs, and providing more advice to people on how to manage their debt.

The report also suggests using refundable tax credits for those with incomes below certain levels, so that borrowers have incentives to earn more.

With both the tax credits and the other provisions, the report urges that family size be taken into consideration.