People Who Are Drowning in Student Loan Debt

Victims of the Student Loan Industry or Irresponsible Borrowers?

I was reading a site called Student Loan Justice as well as a piece at the Huffington Post where people are talking about their “overwhelming” student loan debt that is – wait for it – $15,000 or $30,000.  Basically, less than the value of a car.  Or tobacco costs for a couple, both of whom smoke a pack of cigarettes each day for five to ten years. Or 4 to 8 months of pre-tax income for the average American household.  Sure, that’s real money but for a credential that takes the average lifetime earnings from around $1.2 million to $2.1 million, it’s an extraordinary bargain.

Maybe I’m not sympathetic because, as you know, both Aaron and I, as well as most of our friends, were first-generation college students that had to pay our own way through school (complete with a $140,000 price tag for each of us over four years – by the time all is said and done, our ultimate out-of-pocket costs will exceed $200,000 and that is after accounting for the fact I was able to cover at least half of the cost with a vocal performance scholarship in classical music, as was Aaron, which took years of effort and study).  Before I signed a single loan document, you better believe I had read through all of the fine print so I understood the terms, conditions, and pitfalls.  Even so, we were incredibly frugal.  You all saw the picture of the 1993 Ford Escort Aaron drove with 150,000+ miles long after we had started our first company and he was financially self-sufficient. I mean, he didn’t have heat or air conditioning and drove it during Midwestern winters with ice and -20 degree windchill and summers at more than 100 degrees even though he could have written a check for a new car, while a lot of people we knew bought new cars on credit despite not having any savings or investments.  (I’m going to offer the usual disclaimer here: People who develop health problems get a clean pass because if you are hit with something really terrible, it can devastate your finances and at that point, staying alive and healthy is more important than you credit score.)

These people complaining are rational, full-grown legal adults who have the power to vote.  They made a decision to borrow money, pay interest for the cost of “renting” that money, and then when it’s time to repay, want the government (read: everyone else, including you and me) to pony up the money because it’s cutting into their standard of living.  The entitlement is obscene.  One guy on the site, not that long out of college, complains that he has a $1,250 per month payment and can’t live in New York City.  Then get the hell out of one of the most expensive cities in the world! I read a study a few weeks ago that showed New York was the single most difficult metropolitan area for a new college graduate to build wealth.  If you choose to take on a situation where the odds are against you, don’t complain when you don’t win.  Choosing your battles is the first and most important part of coming out ahead in life, just as it is in war or any other undertaking.

I guess I just don’t understand the mindset that if a full grown man or woman agrees to take something (money) in exchange for something else (the interest rate), why they think they shouldn’t have to live up to the deal to which they agreed.  Now, if the contract were breached, not paying may be a rational form of protest.  In the case of a company insisting on money to which it isn’t entitled, many sane, responsible people wouldn’t cut the check.  But these people acknowledge that they borrowed the money, that they agreed to a contract they didn’t understand, now expect someone to fix it for them.  It seems like they want their cake without the calories (maybe I’m wrong).  They want to have two cars, a decent house, nice clothes, a couple of cell phones, and an X-Box, and they think it’s the bank’s problem they can’t have that because of their student loan payment to which they agreed! Why should anyone else be responsible for managing your life?

In the interest of fairness, I should point out that the student loan debt market is a complete scam because Congress made private student loans virtually non-dischargable in bankruptcy a few years ago, which is utterly and completely indefensible.  Why should one type of loan be protected from market forces?  Sure, costs would rise if defaults could occur, but the pricing mechanism would reflect true economic reality and you wouldn’t get people locked into what become lifetime handcuffs engraved with the words “Sallie Mae” or “Citibank” on them.  However, every student was warned about this before they borrowed the money.

The master promissory note from a typical Sallie Mae loan is short, well-organized, to-the-point, and written in plain English! I went through it and highlighted the sections that clearly spell out all of these “predatory” policies that supposedly “cheat” people out of their money. It’s clear, in black and white, exactly what will happen if you don’t make your payments.  If you’re too lazy to read two pages and you sign your name to the document without understanding it, how can anyone feel sorry for you (unless you had health problems because then you get a pass because you didn’t do anything wrong)? You agreed to the terms and it explicitly explains how it will happen.  Read it for yourself.  You can click the images (see below) for the full-screen, highlighted version of the Sallie Mae Master Promissory Note. If you don’t pay the balance, and interest is capitalized (added to the principal) so that you start to pay interest on interest, of course the balance can go from $25,000 to $300,000 over 20 years, just like an investment account can compound. It even says in plain English that they will apply any payments to the interest and penalties first before paying down your balance. If you didn’t like those terms, WHY DID YOU TAKE THE MONEY?!

Sallie Mae Master Promissory Note Full Disclosure Sallie Mae Master Promissory Note for Student Loan Debt

Each of us has to make decisions about our lives.  Each of us has to bear the responsibility of those decisions.  All of the math you needed to know the real-world consequences of borrowing money was learned by the end of elementary school.

  • While the blame could probably be divided between the creditor and the borrower, most of it has to lie on the shoulders of the borrower. The creditors certainly go out of their way to make it seem like free money, but the borrower has to be smarter than that. The creditors are relying on the borrowers to ignore the small print so that they don’t weigh all their options before applying for a loan. That, however, doesn’t mean it is their fault. The borrower has the responsibility to read what they are getting into before they do.

    Additionally, there seems to be this sense of entitlement that is ingrained within our society. It is certainly justified if you work hard for what you have, but I get the impression that many people are thinking in the back of their minds that credit cards and loans are deserved simply on the basis of existing. The idea of actually having to pay back that money and follow the rules that they signed is insulting to their personal image. I think this is the most serious problem with people defaulting on loans.

    That being said, most 18 year-olds are not rational, nor are they adults mentally. There is a common argument that if a person has the right to smoke, vote, and die for our country, they should be able to drink. I agree completely. The only difference in my argument is that I feel the age of majority should be raised to 20 or 21. the idea that a person is ready to be a full member of society at 18 is outdated and based on an agrarian economy. Today’s society requires some type of education in addition to high school to be successful. It seems logical to me that raising the age of majority to 20 would make it easier for teenagers to get some sort of technical education while allowing for their immature brains to grow. By 20, if an adult wants to be reckless with student loans without a cosigner, I have much less sympathy. At 20, with 15 years of education, the idea of interest and living within your means should hopefully be well ingrained in their minds. If not, then we are all doomed. People have never failed to surprise me with their stupidity before, however.

  • Marvin Lee

    I see great insight in this blog. I believe in investment and saving money to decrease the use of debt. Of course, I’m a first generation college student in my family, so I had no choice but to take out loans due to immigrant parents.

    Many families that have money don’t have enough to help their college-age kids. Why? Retirement funds are the forte for anyone after emergency savings has been built. There are no scholarships for retirement. Hence, many students are forced to borrow money and work on the side. The other reason is that most parents are middle-aged (ever so close to retirement) by the time their first child attends college. I believe marriage is fine when both parties are ready. Also, a late marriage is a plus too if done correctly because both spouses will marry without excess baggage (debt). That means money is available to save money for emergencies, college funds for kids, retirement and other goals.

    Even for a college graduate without that dream job, a part-time job is not enough to cover expenses during college. Scholarships and grants helped me out. I even earned money writing for the school newspaper. However, all that free money and hard work were not enough to cover the rest. Hence, loans are a reality for many.

    I like the idea of a dividend portfolio. However, the main problem with the global recession is the cutback on dividends by companies. Banks realized that paying high dividends were the main reason why they didn’t have the money when the economic crunch came. It is smarter for companies to reinvest investor’s money so that it grows. Otherwise, what’s the whole point of investing in a company? So you can receive money from its profits. Nonsense, the money is for the company to grow and operate for years to come. Plus, a shareholder does not grab too much of the profit pie unless you have at least 10% ownership (you need a lot of money to reach this level). If you want a huge profit earning ratio, it’s better to be an all-right owner without executive and/or managerial duties of a company. In other words, it makes more sense to be a founder of a company and grow it to a size worthy of a place in the stock market with a management firm so you don’t have to be a part of it anymore.

    This blog is great, but it can be improved by fusing it with other personal financial topics such as how to build wealth while tackling debt, establishing an emergency fund, save for retirement, buy insurance policies and meet day-to-day needs. In other words, the bigger picture scenario is more effective and helpful to others in the same boat.

    On a good note, I expect more interesting topics from your blog.

    • Joshua Kennon

      Welcome to the site! I realize this is two years late. I apologize for not seeing it sooner.

  • Landon Jacobsen

    Sorry this question is so long after you wrote this post, but it’s an easy one! How did you come up with the amount $30,000? Is that an arbitrary number or the result of a calculation?

    • Landon,

      The site I referenced had stories from people who said they were drowning under their debt load. A lot of the posts were talking about how they just couldn’t handle $15,000 in debt. Some were about $30,000. Those seemed to be the range I came across the most back when I read it (It’s been awhile so the site could have changed by now) so I stuck with it. I also know the average student loan debt is roughly $21,000 so that range fit within the typical experience.

      Joshua

      • P.S.: The actual number as of 2010:

        Two-thirds (65.6%) of 4-year undergraduate students graduated with a Bachelor’s degree and some debt in 2007-08, and the average student loan debt among graduating seniors was $23,186 (excluding PLUS Loans but including Stafford, Perkins, state, college and private loans).

  • Landon Jacobsen

    Joshua,

    I’m sorry, I guess I wasn’t clear in my question. The $30,000 I was referring to was the amount that you will contribute to your so called “University Trust Fund.” Sorry for the confusion.

    Landon

  • Ah, right. Because the loan itself was $26,019.36 and I didn’t want to go to the trouble of making a deposit for that bizarre amount so I’d rather just round up and say $30,000.

    I could have just as easily created a perfectly offsetting trust of $26,019.36.

    In terms of specific math:

    It is going to come down to an interplay between the dividend yield and the effective debt yield on your debt. Ideally, you’d want the two figures to be identical but that isn’t going to happen in most cases.

    Say you had $35,000 in student loans and your interest rate was a fixed 8.5%. That means you are paying $2,975 in interest annually.

    If you could earn 4% in dividend yield from a widely diversified collection of low-risk blue chip stocks that were stable enough it wouldn’t matter to you if they fell 50% or went up 50% (you are interested in the dividend payout), you would take:

    $2,975 divided by 0.04 = $74,375. So, in this case, if you wanted them to perfectly offset each other in year one, you would need to deposit $74,375 into an account instead of paying off the $35,000 debt. Most people don’t have that kind of money available so it isn’t an option for them.

    But, if you expected the dividend rate to grow at 3%, you might be able to do a quick and dirty version by taking a 7% discount rate (4% yield + 3% growth = 7%), and going $2,975 divided by 0.07 = $42,500.

    In that case, you could either pay off your debt at $35,000 or you could create a dividend trust with $42,500 and use it to make the debt payments each month. At some point, they should reverse out so the dividend income exceeds the debt payment each year. This might not happen if you have another great depression and the companies cut their dividends and collapsed, so some people prefer to mix in some corporate bonds or other assets depending upon their tax bracket.

    If you happened to consolidate when rates were at 3.25% and you could earn 4% in dividend yield, then you would have the happy fortune of being able to deposit less into the dividend trust than the debt balance. For example, your interest cost would be $1,137.50 and not $2,975 ($35,000 x 0.0325 = $1,137.50).

    $1,137.50 divided by 0.04 = $28,437.50 or you could do the quick and dirty 7%,
    $1,137.50 divided by 0.07 = $16,250

    So, in normal market conditions a $16,250 dividend trust today with 4% yield and 3% growth in dividends should, over time, be enough to pay off the debt itself and then start growing on its own. It’s like a self-created trust fund.

    The actual calculation is a bit more complicated than that (you can’t just take 4% + 3%) but it is going to get you almost the same answer you need. It is a paraphrase of a technique Graham used to calculate maximum p/e ratios on stocks.

    For most people, I would tell them just to wipe the debt out completely because they can’t handle watching their stocks and bonds fluctuate. The average person just isn’t equipped for it emotionally, even if it has a higher probability of making them richer in the end. That “emotional” risk must be factored into the decision.

    Hope that made sense …

    • Cbord777

      Yes.  This is the best post in the thread.  Earning a tiny spread yield on your debt is just not worth the mental anguish of continuing to carry debt–especially debt that is nondischargeable in bankruptcy.  Disasters can happen to the best of us (large income reduction, huge increase in medical expenses, etc.). 

      If disaster hits your personal life AND your stock portfolio (ie:  JNJ implodes like many formerly “safe” stocks) and your income tanks, the student loan debt will still be there.  I have student loan debt at 3.75%, but I would pay it off in a heartbeat if I received a windfall.

  • Spingus

    What about some dumbass who has $200k in student loan debt?  (not saying I know anyone like that….)
    the current availability of the Income Based Repayment will get their monthly payments to an ‘affordable’ amount based on poverty level calculations and at the end of 25 years the remaining balance would be forgiven.

    Is there any reason to try and pay the loan off?  Or should the person just think of their monthly payments as stupid tax and put any disposable income they have into retirement investments?

    • Joshua Kennon

      If there were no hope of earning a high enough income in a chosen profession to satisfy the loan so that income based repayment was necessary, and we know that Congress has now limited the ability of bankruptcy restructuring or discharge on student debt, the most rational course of action would be to make the minimum payments possible and have the loans forgiven after 25 years.  Thinking of it as a stupidity tax on youthful indiscretion would probably make it more tolerable.

      • Patrick

        Thank you. Totally willing to admit my former (hopefully) stupidity here. That’s a tax I’ll pay, at least until I can manage otherwise. I also understand though that after 25 years, the forgiven amount is taxed as income.

  • Lynnembrown1

    I am 40 took on debt that I thought I could pay off, worked for many years before I made the decision for grad school then the interest, lack of work in my field, and other life circumstances made it so that I am not going to owe 235, 000.00. My job pays 480 a week. I have decided to live on a friends couch and not have a family due to the debt so I can pay this. But with two masters degrees from an ivy league and another top school I don’t think I should be living in this debt. But I am. And it’s wrong. I don’t mind paying a normal  or rather rational amount every month but the interest rates alone are killing everyone . 

    • Joshua Kennon

      With figures like that it is possible – possible, mind you – that you could be the exception and qualify for a discharge in bankruptcy.

      If that is the case, be done with it. Take the nuclear option. You lose your credit for seven or ten years … big deal compared to the financial hell you are living in now. Talk to a bankruptcy lawyer and examine your options. He or she will be able to look at your individual situation and circumstances to advise you.

  • jwebber12

    I’m 22 and next year when I’m done school, I will have about $47,000 in student loans between undergrad and graduate school. The University Dividend Fund sounds very appealing but I’m curious as to whether it is actually feasible for someone in my situation. I have the option to defer all of my debt for 2.5 years until Dec. 2014. Would it make sense for me to save up as much money as I can until then, investing in mutual funds, and then attempt to do the UD Fund idea with whatever I have – or should I just start making loan payments now? Would the prinicples behind the UD fund even still apply if it’s underfunded (below my debt amount)?

    • Joshua Kennon

      I am sorry I never saw this message!

      If it were me, and I were in your position, I would just pay off the debt. Student loan debt is now a special protected type of debt that can be almost impossible to charge off in bankruptcy. My situation was different. As a college student, my household was earning six-figures, I had already stuffed brokerage and retirement accounts with stocks and other assets, and both of us were still, technically, unemployed, sine we worked for ourselves, meaning that getting a job would have just added to the money. On top of all of this, I was able to lock in interest rates that are extremely low by consolidating at the same time the Federal Reserve was driving down rates to try and save the economy.

      The debt posed no risk for us. Very few people are in that position. If I were you, I’d just wipe your student loan debt out. I’d do everything in my power to pay it off and be done with it. I wouldn’t defer, I wouldn’t put it off, I’d bite the bullet and get it behind me so I could start over and begin building assets.

      I have never heard a single person say, “I wish I hadn’t paid off my debt.”

  • Jay Tank

    The Dividend Trust Fund sounds good in theory, but what about including taxes into the picture? Wouldn’t you have to contribute more than just the interest? Also, wouldn’t it take many years before you start paying off both interest AND principal of the loan?

  • Are you / would it be a good idea to pursue a similar approach for your primary residence? A Home Dividend Trust, if you will. It sounds like this would be equally applicable, unless I’m missing some pros/cons here.

  • Joshua, this is going to make you spit out your coffee, but in case you haven’t seen this recent article in Vice News on 4 Americans who are avoiding their student loan obligations by living in Europe.

    Some of the things these people are saying are so bizarre and with so much mental gymnastics going on, it would make an incredible case study on a real life example of a negative lollapalooza effect and the detrimental effects it has on your life.