The Finance Buff

Student Loan vs Mortgage

by on 10 Comments

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.

Comments

  2. I’m curious what you think about the connection between readily available student loans and tuition increases. Some people are saying that student loan availability is behind steep tuition increases and that if loans are restricted, tuition is likely to come down (or at least not rise so fast). Does that make sense to you?

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  3. There was an awesome PBS Frontline about the college industry named “College INC”. You might can find it for free online. It is an amazing peek into the absolutely absurd for profit college industry that is using government backed loans to get filthy rich. They have no concern on how these students are going to repay the loans. Students are seen as income not people. You can’t file bankruptcy from student loans. These guys get paid no mater what. They don’t care if you fail out. You still have to pay…and they will find someone else to get another government backed loan to fill your seat.

    Unfortunately these schools have an incredibly strong lobby who don’t have the students well-being at heart. And unfortunately students don’t give much money to finance political campaigns.

    I recommend this documentary to anyone.

    (Note: my wife have over 300,000 in loans for private college and graduate degrees) Ouch!!!

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  4. I agree that the easy availablility of student loans is a big factor behind the dramatic increases in tuition. With all the money available for loans, universities are remodeling dorms into luxury apartments to compete with each other for students. Instead of just trying to regulate the terms of loans, why doesn’t the government focus more on bringing the costs of education in line? My kids are getting the same deal my parents gave me. I’ll pay for any in state public college or the equivalent. I graduated from a Big Ten school with with an undergrad and MBA in 5 years with no debt. My first kid also graduated from a great in state public college with no debt. Hopefully, we will have the same result for my sophomore in high school. My cousin is a doctor about to turn 30 and swimming in debt. Wait until he sees the bite that Uncle Sam takes once he starts making decent money. It will make it that much harder to pay off.

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  5. @shuchong – I think there is a very strong connection between availability of loans and college tuition and fee increases. It works the same way as how loose credit in mortgages pushes up housing prices. After lenders tightened underwriting (higher down payment, conservative appraisals, documenting income, …), house prices came down and stopped rising as fast.

    @Ricky Bobby – Thank you for bring up College Inc. It’s still available for free viewing on PBS website.

    Businesses sell stuff. Homebuilders sell houses. Automobile manufacturers sell cars. Tiffany & Co. sells jewelry. Apple sells iPads. For-profit colleges sell education services. I don’t blame them for selling their stuff. Are the products worth the price? Somebody must make that call. If students are not doing a good job in judging prices and quality because they are spending borrowed money, the lenders have to do that. I think the federal government only has itself to blame when it gives up underwriting.

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  6. Here’s an even more scary fact: While new legislation was needed before the government could bail us out of the mortgage crisis, the bailout is built in to the student loans. All federal loans (the vast majority of those owed by students) are already guaranteed by the federal government. No bailout bill required.

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  7. Student loans are not the cause of large tuition hikes. Two factors are the cause of faster-than-inflation tuition hikes.

    1. The primary budget item of a college or university is the salaries of its faculty and staff, and a large portion of that cost is the benefit plans. Medical costs have been rising faster than inflation for over a decade. Even if faculty and staff wages only match inflation, the primary budget item still grows faster because of the cost of benefits.

    2. As state budgets have become strapped, they have needed a place to cut costs. State colleges and universities have sources of income (i.e. they collect tuition). Do you cut a program for poor people that takes food out of the mouths of the unfortunate, or do you cut higher education which can compensate to some extent by raising tuition?

    The last time I looked at a graph of the tuition rises at a state university, it was more than beat by the reductions in state appropriations. Faculty and staff salaries have been nearly stagnant, yet tuition rose faster than inflation to compensate for the reduction in appropriations and the rise in the cost of medical insurance.

    I don’t know how the math works at private institutions, except that in some cases faltering endowments (i.e. drops in the stock market) acted in the same way as reductions in state appropriations affected state schools.

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  8. @Don
    I respectfully disagree. The lack of lending standards and overabundance of student loans is a major factor, if not THE major factor, in tuition increases.

    As you point out, “The primary budget item of a college or university is the salaries of its faculty and staff.” What you fail to mention is that the growth in administrative positions are greatly outpacing the growth of faculty position at most universities. Many people refer to this simply as “administrative bloat.” In other words, a larger portion of a student’s tuition is paying for non-essential university/college position.

    As you also point out, state funding tends to decrease during economic downturns. But if we look at the University of California system, for instance, tuition increased by 73% in only 3 years during the peak of the housing bubble. So tuition has been increasing rapidly in good times and bad.

    An important thing to note:
    As it currently stands, ALL student loans are effectively subsidized by the federal government for two reasons:

    1) Many, if not most, student loans have been issued or purchased by the federal government through quasi-government agencies.

    2) The federal government has made it virtually impossible to discharge student loans. As a result, there is no need for lending standards. No lending standards mean a greater availability of student loans, which makes rapid tuition increases possible.

    In the end, absent the government’s massive financial/legal subsidy that has created an overabundance of student loans, tuitions would have no choice but to come down.

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  9. On a related note, President Obama just announced a plan to provide student loan “relief” by limiting borrower’s annual payback amount to 10-15% of his income and capping the loan repayment period to 20-25 years. Here’s an example from the article:

    “If Suzy Creamcheese gets into George Washington University and borrows from the government the requisite $212,000 to obtain an undergraduate degree, her repayment schedule will be based on what she earns. If Suzy opts to heed the president’s call for public service, and takes a job as a city social worker earning $25,000, her payments would be limited to $1,411 a year after the $10,890 of poverty-level income is subtracted from her total exposure.

    “Twenty years at that rate would have taxpayers recoup only $28,220 of their $212,000 loan to Suzy.”

    If this goes through, there will be no stimulus for students, only a huge taxpayer subsidy to the schools they attend. In the end, these same students will carry the huge tax burden of the exploding government debt that is a result.

    http://www.foxnews.com/politics/2011/10/26/obama-taps-taxpayers-for-student-stimulus/#

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  10. The cost of college has skyrocketed because colleges know and take advantage of the fact that whatever they charge, the government will pay in grants and loans. I read a few years ago the government started requiring the ivy league schools to start pitching in with grants if they wanted fed money.

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