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The $1.4 trillion federal student debt market faces a huge issue — transparency

The Honorable Sheila C. Bair

When it comes to federal student lending, the bad news just keeps coming. Federal student debt now exceeds $1.4 trillion and fully half of that is not being repaid. More than one million student borrowers default each year.

Nearly 40% are expected to default by 2023. (For context, during the financial crisis and its aftermath, mortgage delinquencies and defaults peaked at 11.5%.) Much research and study have been devoted as to why so many student borrowers aren’t paying their loans. Part of the answer may be that they never fully understood they were borrowing because of misleading marketing.

Imagine that a bank offered to help you buy a car. Let’s say that the bank sent you a letter offering a variety of different types of “aid” without clearly specifying that some of the “aid” was in the form of a loan that you would have to repay. Let’s say that the bank also didn’t disclose to you the total amount you would have to borrow to get the car or the interest rate and other key terms of the loan before you committed to its offer. Would you take the deal?

I hope not!

A lack of skepticism and regulatory oversight

Americans are somewhat wary when it comes to borrowing money from banks or other private lenders. While more can always be done to educate the public on the risks of unaffordable debt, most of us know enough to ask questions and nail down repayment terms before we commit. In addition, private lenders are subject to state and federal consumer protection laws that would never permit them to market a loan in such a misleading way.

Unfortunately, the same amount of consumer skepticism and regulatory oversight is not present when the government is the one providing that “aid” in the form of student loans. Indeed, millions of students and their families routinely commit to borrow tens of thousands of dollars from the government to finance their student’s higher education before they receive any clear disclosures of key loan terms or even understand the total amount they will likely need to borrow for the student to complete her degree.

Federal student loans are marketed around the notion that they are a benefit provided by the government to gain access to higher education, not a financial obligation. Students and their families are encouraged to make maximum use of that benefit and since it’s coming from the government, many just assume it’s in their interests to do so. Government and college websites lump loans into the category of “financial aid” along with scholarships, grants, and work study. Loans are arranged through colleges which send “award letters” to student applicants once they are accepted at a college. These letters are not subject to Truth in Lending regulation and vary widely in explaining how students will need to finance college costs. An analysis of 11,000 award letters by the New America Foundation found that less than one-third clearly distinguished debt from grants and scholarships that do not have to be repaid. A significant number didn’t even use the word “loan,” instead characterizing debt as an “award.” Perhaps this is one reason why an earlier study by Brookings found that 28% of first year student borrowers didn’t even know they had federal loans.

To their credit, the Department of Education and the Consumer Financial Protection Bureau have developed online tools to help students understand and compare the costs of attendance and their post-graduate debt obligations. However, these tools are voluntary and hampered by lack of consistency in how “aid” is disclosed in college award letters.

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