Fans of the 1970s classic sitcom “The Odd Couple” might remember the episode in which Oscar Madison introduces his roommate Felix Unger to his sleazy insurance agent from Lloyd’s of Lubbock, whose come-on is that he offers you a policy just by shaking your hand. It appears that Lloyd is back in business, only now he’s working for the federal government. Or at least his underwriting guidelines have been adopted by the U.S. Department of Education.
The Wall Street Journal published a long story on Monday about the federal Parent Plus loan program, which it says “asks almost nothing about its borrowers’ incomes, existing debts, savings, credit scores or ability to repay. Then it extends loans that are nearly impossible to extinguish in bankruptcy if borrowers fall on hard times.”
And lots of them have. As of September 2015, 11% of Parent Plus borrowers hadn’t made a payment on their loans in at least a year, which “exceeds the default rate on U.S. mortgages at the peak of the housing crisis.” And the problem is only going to get worse. The number of families with Parent Plus loans has jumped more than 60% since 2005, the Journal reports, to 3.5 million at the end of last year. They owe a combined $77.5 billion, or an average $22,000.
To its credit, the Journal not only exposes this scandal – or it would be called a scandal if it were perpetrated by private lenders – but also calls it accurately for what it is. “Parent Plus is one thread in a web of higher education loan programs that have come to resemble the subprime mortgage industry a decade ago, given the shaky quality of many of the loans.”
“If Bank of America did that, Sen. [Elizabeth] Warren would have them in the biggest hearing you’ve ever seen,” Betsy Mayotte, a consumer advocate, told the Journal. Needless to say, the esteemed senior senator from Massachusetts has gone out of her way to excoriate private student loan lenders, who would have had the common sense to not make such loans in the first place, but not a peep about what goes on in the education department down the street.
The scandal that is the federal student loan program – whether it's loaned to students themselves or their parents – touches a nerve with me because my son will be entering college this fall and I’ve seen first-hand the Lloyd’s of Lubbock-style of underwriting our government does. It doesn’t really do any underwriting at all.
If you’re new to the modern college experience or about to enter it, it’s a real eye-opener. It makes you wonder why it’s taken so long for the mainstream or financial press to finally wake up and notice what’s been going on for the past decade or so.
Positively the most important application a parent of a prospective college student will need to complete isn’t the application to a school itself but the FAFSA, which stands for the Free Application for Federal Student Aid (don’t be fooled by the name; the application is free, nothing else about it is). Just by completing the FAFSA, your son or daughter is guaranteed a $5,500 loan for their freshman year, plus another $6,500 as sophomores and $7,500 as juniors and seniors, putting them in debt to the tune of $27,000 by the time they graduate should they agree to take out the loans.
Most of the colleges and universities I’ve seen automatically include a FAFSA loan in the student’s “financial aid” package, as if it’s assumed the student will take out the loan and that the loan is no different than a scholarship or a grant, which don’t have to be repaid.
(The FAFSA is another scandal in itself. The online tool that allows applicants to electronically autofill the form’s financial data with their IRS tax return information was recently hacked, enabling thieves to apply for bogus student loans using stolen tax information.)
Not surprisingly, given that there’s little in the way of actual underwriting, the default rate on loans made directly to student borrowers is in the stratosphere. According to the Journal, which used data from Equifax, “nearly four in 10 student loans—the vast majority of them federal ones—went to borrowers with credit scores below the subprime threshold of 620, indicating they were at the highest risk of defaulting. That figure excludes borrowers, such as many 18-year-old freshmen, who lacked scores because of shallow credit histories. By comparison, subprime mortgages peaked at nearly 20% of all mortgage originations in 2006.”
Now that’s just the loans made to students, which understandably are high-risk given that the borrowers hadn’t even finished high school when they applied for the loans and many don’t have jobs yet. But the Parent Plus program is nearly just as bad. Unlike loans to students, which are capped, there is no limit on how much parents can borrow. And according to the Journal, “the program checks only a borrower’s past five years of credit for major blemishes such as bankruptcy or foreclosure, and the past two years for delinquency on debts of more than $2,085.”
So where’s the outrage? It came not from borrowers and taxpayers – or Sen. Warren – but the colleges, which complained when the Obama administration tried to put in tighter restrictions in 2011, which it then rolled back.
What’s the solution? Force colleges and universities to have some skin in the lending game – and a lot of it. Otherwise we can expect the Lloyd’s of Lubbock style of underwriting to continue to exacerbate the student loan crisis.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.