Misguided Student Loan “Solutions”

ABC News is reporting that Congress is set to take up a student loan fix, but it’s difficult to fix a problem you have yet to define–much less understand. But when has that ever stopped Congress before?

What is the “student loan problem” to be fixed? The immediate issue is that the interest rate for new federally subsidized loans is set to double on July 1, from 3.4% to 6.8%. Republicans are offering a plan that would keep rates from going up as much in the short-term, but could potentially increase several years down the road (assuming Congress wouldn’t step in to stop it then…as they’re trying to now). Democrats, on the other hand, simply want to extend the current 3.4% rate…ostensibly for just two years, while working on a long-term fix (a familiar tune). Democrats believe that, by keeping the price of student loans artificially low, they are helping the average person or family better afford college.

And this is the point where economic reality (and the real student loan problem) is promptly ignored. Continue reading Misguided Student Loan “Solutions”

The Real Problem With Student Loans

Suppose you want to make an investment in a long-term asset that pays off over the next 45 years. You go to the bank and ask for a loan to pay the up-front cost of the investment with the promise to pay the funds back once the asset begins paying returns.  The bank offers to loan you the funds at an interest rate of X% that reflects the risk-adjusted cost of making the loan based on the riskiness of the asset and your likelihood of repayment.

In any normal context, you would look at the interest rate, look at the expected payoff of the investment, and determine whether or not the investment still made sense given the cost of borrowing the money. If the cost of the loan to make the investment was higher than the expected payoff, then you would either seek a cheaper loan or you would forgo the investment.

That is, unless it’s a student loan. And THAT is why we have a student debt problem. Continue reading The Real Problem With Student Loans