News came that outstanding student loans will top $1 trillion this year. The Obama administration recently announced some tinkering on the edges to help lower the interest on student loans. Some say student loans have become a burden that could place a drag on the economy.
How did student loans become such a large problem? It’s obvious to me that, like the mortgage problem, the student loan problem is also an underwriting problem.
The prevailing opinion is that we have a mortgage problem because banks didn’t do an adequate job in underwriting the loans. People who couldn’t afford loans got loans. When house prices stopped going up, we ended up in a mortgage crisis.
Compared to mortgages, student loans are far worse in terms of underwriting. In fact there isn’t much underwriting at all.
There’s no down payment. If a student (or family) wants to borrow 100% of the cost of education, nobody is stopping them.
There’s no collateral. You can’t take away one’s education if someone doesn’t make the loan payments. Therefore the student loan lenders are given strong collection rights. The flip side is that there’s nothing to walk away from. Student loan debt can’t be discharged in bankruptcy.
There is no equivalent to an appraisal — assessing whether the price the school charges is in the ballpark of reasonableness. Nobody looks at “comps” and denies a loan if the tuition is too high. If the student falls in love with a school and wants to pay three times more than the cost of another school, so be it.
There’s no equivalent to a cap in debt-to-income (DTI) ratio. Nobody looks at the field the student wants to study in and says it doesn’t have the income potential to support the loan payments after graduation. If you want to pay a lot of money to pursue your dream in a low-paying field, just borrow away.
Without much underwriting, no wonder sky is the limit on student loans and college expenses.