Novel Idea: Grant Student Loans Only To Students Likely To Repay Them

Forget residential foreclosures. Student loan defaults may be the next big thing.

Somehow I am willing to bet that President Obama, who announced his new college loan plan today in Denver, may have missed a great piece on student loans by Jackson Toby. As it turns out student loan defaults and foreclosures have a common root:

As with sub-prime mortgages, the Department of Education, Sallie Mae, and banks gave students loans without scrutinizing their ability to repay them. Congress hadn’t asked them to.

Toby proposes that a student’s credit history and academic records be taken into consideration when deciding whether to make a loan. Toby says that loan defaults “threaten to blow a huge hole in the federal budget:”

The federal government guarantees repayment of most student loans. Therefore, each loan default eventually adds to the deficit. Initially, the cost of defaulted loans was negligible because the federal loan portfolio was small and the majority of graduates were paying loans off. But the rising cost of defaulted student loans is now receiving more attention.

The Department of Education announced on September 13 that the overall default rate for federally guaranteed student loans had risen to 8.8 percent for the fiscal year ending on September 30, 2010, up from 7 percent the previous year. This was the highest default rate since 1997.

As of this year, students and former students face an accumulated debt of around $1 trillion on student loans, more than the total of American credit card debt. The difficult job market means that many of these students will either have a hard time repaying this debt, or, worst, that they will default.

I know I’m on a soapbox about college loan debt, but we really need to do something even more basic than trying to predict that borrowers will be able to repay their loans (though it goes without saying that this is important).

We need to ask why tuition is so high and if there are alternatives. I am intrigued by this college where there is no tuition because all students work their way through school. No, this particular college is not everybody’s cup of tea. But it is the kind of original thinking we need.