NEW YORK —If you're in the market for higher education – but can't afford the hefty price tag out-of-pocket – get ready to pay a tax on your ambition. The interest rates paid on federal student loans (especially at the graduate level) exceed those for other notes, effectively placing a tax on the most ambitious. A recent study by the New York Fed sheds light on the growing burden: Student loan borrowers are for the first time less likely to obtain mortgages or auto loans. That's capital being diverted from ostensibly more economically productive activities to debt repayment.
If some economists argue austerity policies (such as higher taxes) are partly to blame for anemic economic recoveries, then the burden of student loans can be seen as a form of "private austerity," depressing borrowers' ability to save and consume. Student loan expert Heather Jarvis explains that this phenomenon's impact extends beyond the borrowers.
"Higher student loan burdens are limiting people's ability to participate fully in the economy, and this will have long-term, downstream consequences," she said. "They not only can't afford mortgages, but they also can't afford to invest or save for their own children's education. It creates a vicious cycle that impacts upward mobility."
Market-Sensitive Interest Rates?
For years, higher education was seen as a means for accelerating that mobility, and programs such as the G.I. Bill, federal grants and subsidized student loans put that dream within the reach of many. But even as the recession gained steam, most tuition bills kept growing, making college less affordable for struggling lower and middle class families.
Some federal loans (such as Grad Plus loans) bear fixed rates as high as 8.5%. With other borrowing costs at historically low levels, Jarvis thinks fixed student loan interest rates may be part of the problem.
"There is only so much the federal government can do to directly reduce education costs, but fixed interest rates for students are most concerning, because it's an example of how the cost of student borrowing is out of line with market forces," she said. "Variable interest rates would more strongly reflect the economy."
Variable rates would, of course, more closely mirror economic activity, but it's debatable whether they'd actually make college more affordable. Student loan industry activists note that federal loan's higher rates partly reflect the lower credit quality requirements. Lower the interest rates, and the government assumes an even greater risk in the event of defaults. That may have the unintended consequence of reducing federal loan availability for the neediest.
20 Years to Freedom
The government responded to the onerous burden of student loan debt by creating new income-sensitive federal loan repayment programs such as Income Based Repayment and Pay As You Earn. These programs enable borrowers to repay based on their earnings, capping payments at 10 or 15% of disposable income. For those having difficulty repaying on a traditional ten-year schedule, they can help reduce delinquency.
But the programs also have their drawbacks. Although all remaining debt is forgiven after 20 or 25 years (PAYE and IBR, respectively) of repayment, it still means borrowers are on the hook to the federal government for decades, often seeing their balance balloon despite making regular payments. And because these are government-run programs, collections on delinquencies can be a lot more aggressive — including garnishing wages, confiscating tax refunds and imposing hefty collection fees of up to 18.5%.
Still, Jarvis, says, these are a lifeline for families struggling under the trifecta of higher tuition, lower student aid and limited professional opportunities,
"IBR and PAYE truly are helping students with loans – but whether they help enough is the question, and the fact that they need them even more now is the problem," she said. "Paying on loans for 20-25 years is hugely problematic, as is the whole debt-based program of educational access. But it's needed now that grant and scholarship money is more limited."
Student Aid Market Cycles?
There's another parallel to the student loan – economic austerity argument that has gone unmentioned. Lower levels of scholarship and grant aid are partly a reflection of shrinking state and federal education budgets and reduced private giving in response to the recession. So, federal loan burdens (at least for new borrowers), much like higher taxes, may ease when economic conditions improve and state and private sources of funding increase.
In times of plenty, austerity eases and taxes tend to decline. The "ambition tax" may, too, if economic conditions improve markedly and borrowers no longer need suffer the burden of heavy loans – or if standard repayment simply becomes feasible again.