Student Loans: The Next Default Crisis?

Student Loans: The Next Default Crisis?

You’d think we would have learned from our mistakes, but it seems like we may be headed for a student-loan disaster that looks strikingly similar to the 2008 mortgage crisis.

Now surpassing credit card debt, student loans have joined mortgages and car loans as the top three sources of debt, according to The New York Times. The difference is that student loans are loosely regulated, a huge problem for borrowers who can't escape their loans through bankruptcy. Borrowers in default have lower credit ratings, leading to more expensive mortgages and even lost job options.

Learnvest

Get started with a free financial assessment.

In 2009, the federal government created HAMP (the Home Affordable Modification Plan), which relied on mortgage servicers to restructure their mortgages—with very poor results. Student loan servicers are under similar pressure from federal overseers, but have little reason to make changes.

It's an example of the "principal-agent" problem: The agent (loan servicers) has minimal motivation to change its behavior according to the best interests of the principal (the owners of the loans—usually the federal government or private banks). The number of student loan borrowers in distress far exceeds the number in more forgiving repayment plans, according to the Consumer Finance Protection Bureau, but loan servicers often don't offer loan forgiveness options at all.

Similar to what led up to the mortgage crisis, bank employees are signing loads of documents without adequately verifying who owns of the loans, a phenomenon known as "robo-signing." This made restructuring mortgages difficult, because nobody knew who could legally change the loans' terms. Today, student loans also fall victims to "robo-signing," creating further confusion and lack of responsiveness.

RELATED: How I Paid Off Over $20,000 in Student Loans in Three and a Half Years

While some experts say we’re overreacting about the potential for a student-loan crisis similar to the mortgage crisis, there’s reason to believe that relying on lenders, who have little cause to act in the best interest of borrowers, is risky—both for borrowers and the economy at large. Though most student loan borrowers do repay their loans without serious issue, those who struggle endanger the economy. Student loans allow millions to receive an education, but when the system doesn't work, the entire economy is exposed.

Learnvest

Financial planning made simple.

Get your free financial assessment.

Related Tags

Get the latest in your inbox.

Subscription failed!

You're Now Subscribed!