Unpaid student loan debt looms as national crisis

The next financial bubble? Add student loan debt to the watch list.

The concerns are growing. So is the rhetoric to do something about the problem.

According to the latest data from the U.S. Department of Education, default rates on federal loans are now at their highest level since 1997. More than 320,000 borrowers fell behind on payments for the period that ended Sept. 30, 2010, the government reported this month. That translated into $2.4 billion in loans in default.

And unless the economy starts showing a stronger pulse, the debt situation is likely to get worse.

The department’s report prompted a proposed resolution in the U.S. House that calls for forgiving student loan debt for all college grads, including those who are throwing every spare nickel every month into paying off loans like clockwork.

The thinking: Forgiving the debt would free up more money for people, especially low- and middle-income borrowers, to spend and stimulate the economy.

As stated in the proposal: “Instead of saddling entire generations with debt from which there is no escape, let’s empower the American people to grow this economy on their own!”

Don’t expect this political sideshow to get very far. True, wiping debt off the family ledger would put more money back in your pocket, and it could even encourage more spending that will move the needle. But it wouldn’t make for sound economic policy, and it might hurt the banks that hold student loans, as well as the federal government, which guarantees them.

Still, mounting student loan debt is very tough to cope with. Borrowers can be financially handcuffed to loan payments for years to come. For those with default checkmarks on their credit reports, the outlook can be particularly bleak.

No doubt, borrowers are feeling strained. They’ve fallen behind on their payments because they’re unemployed or earning little. For many, there’s simply too much debt and too little income.

But in some cases, grads have also managed their finances poorly.

Although 8.8 percent of borrowers overall defaulted on federal student loans as of last September, compared with 7 percent the previous year, the default rate actually peaked at 20 percent in 1990.

Digging deeper into the numbers, the highest default rates came from students at for-profit colleges and universities. These borrowers defaulted at a rate of 15 percent in their first two years of repayment through September 2010. That was up from 11.6 percent the previous year.

This was more than twice the default rate for students who attended public colleges and universities and about three times as high as the rate among students at private schools.

The total amount of student loan debt now exceeds what’s owed on credit cards.

It doesn’t take much imagination to see this scenario continue to spiral downward as jobs and salaries for new graduates become harder to come by.

For many students, loans are the only option for being able to attend college. Luckily, the federal government provides several options for paying the money back. Borrowers need to understand their choices, then figure out the best way to make the loan payments manageable.

Otherwise, the best way to deal with the federal loan program is to try to avoid it as much as possible. Some suggestions:

•Readjust your mindset. Many parents and students think highly selective schools with outrageous prices mean status, identity and guaranteed employment after graduation. The reality: There are many good schools that may offer what you’re looking for at affordable prices.

•Go with the free money. Looking for merit-based aid, which doesn’t require repayment and rewards students with good grades and test scores? Then apply to schools that offer generous scholarship packages.

•Tap Grandma. If the grandparents want to help out with tuition and can afford to do so, take advantage of their generosity.

•Graduate early. Earn college credit through advanced placement classes in high school. Also, test out of entry-level classes in college.

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