Manageable Student Debt: Developing Benchmarks Sandy Baum The College Board and Skidmore College Sau

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Manageable Student DebtDeveloping Benchmarks
Sandy BaumThe College Board and Skidmore
CollegeSaul SchwartzCarleton University

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The Study

• Revisiting the definition of manageable student
  debt levels.
• Is 8 of income still a reasonable benchmark?
• Can we develop income-sensitive benchmarks?

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Multiple Perspectives

• Banking industry standards
• Studies of borrowers in repayment
• Relative living standards
• Need analysis
• Income contingent repayment, wage garnishment

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The Common Wisdom

• HUD standard 29 / 41
• Fannie Mae standard 33/ 41
• Values of 8 to 10 based on banking standards.
• Values from 4 to 15 appear in the literature,
  but 8 is most common.

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Ranges of Estimates

• Hansen and Rhodes (1988) 10-15 depending on
  starting salaries
• Greiner (1996) 4 ---- 12 for non-housing debt
  divided among credit card debt, auto debt,
  student debt

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Evolution of the Banking Industry

• FICO scores have replaced debt/income ratios as
  primary determinant of eligibility for credit.
• Focus is on probability of default, not
  manageability of debt from perspective of
  borrower.

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Credit Scores

• Exact formula proprietary (Fair, Isaac)
• Based on past history of credit not present
  circumstances or future prospects
• Absence of positive credit history biggest
  barrier to loan eligibility
• Automated underwriting process allows debt/income
  ratios to be exceeded.

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What the Bankers Say

• Auto loans can be as high as 64 of income with
  good credit history.
• Student loans are like any other loans.
• Lenders have elaborate analyses of their own to
  set terms of loans within FICO scores.
• Private education lenders Debt/income prediction
  not part of the process.

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How can we replace the 8 rule of thumb?
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Evidence from Borrowers in Repayment Nellie Mae
2002

• Index of perception of burden
• Is repaying your loans harder than you had
  anticipated it would be?
• If you had it to do over again would you borrow
  less? About the same amount? More?
• How burdened do you feel by your student loan
  payments?

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Perceived Burden

• Payments lt 7 of income no problem
• 7 - 11 - sense of burden begins to be apparent
• 12-17 - greater expression of difficulty
• gt 17 clear break in calculated index

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Index Values
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Need Analysis

• Institutional Methodology
• Expectation of contribution from parents of
  dependent students
• Families with additional obligations
• Portion of discretionary income devoted to
  expenditures on education

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Need Analysis

• A minimum? Could be viewed as independent
  students with education as first priority
• A maximum? Parents expected to save and borrow
  not reasonable for debt repayment

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PC as Percentage of Income Family Size 2, 1
in college, 2005-06
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Spending the Earnings Premium(Ages 25-34)
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Income Contingent Loans U.S.

• Maximum of 20 of discretionary income
• Discretionary income gross income poverty
  level

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Other Perspectives

• of income on education overall
• Default patterns relative to debt/income at
  different income levels
• Wage garnishment 10 or 15 of earnings. Up to
  25 with multiple debts.
• Top 10 (or 20 or 25) of payment/income ratios

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Summary

• Minimum income for payments 20,000
• Above 18 problematic at all income levels
• 5-7 through 30,000-35,000
• 40,000 or above 15 not unreasonable

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Options

• Common wisdom 8
• Borrower experience 7 / 18 as breakpoints
  (Can we find income-sensitivity?)
• Need Analysis Minimum income for payment
  expectation - 20,000 up to 18 at 80,000

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Thoughts on next steps?