Learn the three unique characteristics of student loans that make them more dangerous than almost all other kinds of debt.


Student Loans are Everywhere

In a single generation, student loans have ballooned out of control. In 2006 the total amount of outstanding student loan debt was less than $500 billion in the US. Then, in the last 14 years that number has more than tripled to around $1.6 trillion in mid-2020. And, that doesn’t even include new loans that have been taken out as schools started all across the country in August and September.

Americans carry more student loan debt ($1.6 trillion) than car debt ($1.3 trillion) or credit card debt ($0.9 trillion).

But, the sheer size of student loan debt in the US is not the issue. Sometimes, student loans are a valuable tool. They can help people access higher education and change their career trajectory.

The biggest issue is that there are three unique characteristics that make student loans more dangerous than all other types of debt. The three characteristics are:

  1. College debt is not discharged in bankruptcy
  2. Income qualification is backward
  3. Income-based repayment is a trap

Keep reading for more detail…


Student Loans are Not Discharged in Bankruptcy

Sometimes the worst happens. There are legitimate times when life gets out of control and we need help. When the worst happens, bankruptcy can sometimes be a last-resort option to help people overcome hard times.

When you file for bankruptcy, you go to court. All of the people to whom you owe money go to court with you. You tell the court your situation and why you can’t pay. Your creditors argue that you should pay. Then, the court decides which debts you have to pay, and which ones get discharged.

Except for student loans.

Student loans are exempt from regular bankruptcy proceedings.

That means that if the worst happens and you have to file bankruptcy and want to restart your financial life… your college debt will still be there waiting for you on the other side.

That is horrifying.


Income Qualification is Backward

When you apply for a mortgage, personal loan, credit card, or car loan, the lender wants to see evidence that you will have the ability to pay the money back. They check your income to make sure that you make enough money to cover your payments.

All else equal, the more income you have, the more you can borrow.

Except for student loans.

When you fill out the Free Application for Federal Student Aid (FAFSA), you indicate your income and the assets that you have access to.

The less you have, the more student loan debt you can get.

I totally understand the intent. Student loans are intended to be a way to level the playing field and allow students from lower-income families to access higher education. But instead, they trap the lowest-income among us in a repayment nightmare that can last decades!

That is horrifying.


Income-Based Repayment is a Trap

There is another program that is meant to help lower-income student loan borrowers that creates a very dangerous trap. That program is Income-Based Repayment.

If you take out lots of student loans and, after you graduate, you work in a lower-income job, you can ask for your payments to be reduced so they don’t exceed a certain percentage of your income. This is awesome in the short term because it helps low-income families make ends meet.

But, this often means that the payments are less than the interest on the loans, which means the balance will increase over time!

You could pay on your student loans for a decade and still owe more than you originally borrowed.

Income-Based Repayment plans can keep you in debt forever.

That is horrifying.


Bonus: Two Unique Benefits of Student Loans

Student loans are not all bad. They do allow people to access higher education, which can enrich their lives and open up possibilities for higher-paying jobs.

In addition to the three characteristics that make college debt dangerous, there are two ways that student loans are unique and benefit borrowers.

Total and Permanent Disability Forgiveness

If you lose the ability to earn income because of a disability, the government will step in and eliminate your student loans for you. This is unique. Becoming disabled will not change your mortgage, car loan, credit cards, or any other personal loans.

Death Forgiveness

When you die, all of your assets and debts are managed by your estate. Everything you own is used to pay off everything you owe. Anything that’s left after your mortgage, car loans, credit cards, or any other personal loans are paid back is left to your heirs.

Except college debt. When you die, your student loans are automatically forgiven.


Final Thoughts

Student loans are meant to help our students access higher-education. But, in the course of just one generation, they have become a plague on the youth of our country.

College debt can be a great tool to help you access an education that you could never cash-flow with your current resources. The intent of the system is to level the playing field and allow anyone to go to college. And, that is incredibly noble.

But, because they are not discharged in regular bankruptcy, income qualification is backward, and income-based repayment can lead to a lifetime of increasing balances, student loans have become a trap.

Do not fall into that trap. Instead, use student loans responsibly. For more detail, check out my full article How to Decide if Student Loans are a Good Idea. Here are the cliffs notes:

  • Spend as much as you want… if it’s cash
  • If you must borrow, treat it like an investment… know your ROI
    • Stay in state
    • Start at community college
    • Study something you enjoy
    • Study something with a career path
    • Finish as quickly as possible
  • Never borrow more than 2-years worth of your expected increase in income resulting from your degree
  • Pay your loans as quickly as possible after graduation

That means avoiding income-based repayment plans if at all possible.

And, never refinance your federal student loans into other kinds of debt. If you do, you will lose the only real benefits of these kinds of loans: forgiveness in death or disability.


I hope this has been helpful! I welcome your comments with your thoughts and questions. And, don’t forget to subscribe to the newsletter to get notified whenever a new article is posted.

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