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Comment by lutorm | Hacker News Reader

I must be missing something basic here: If someone refinances their student loan, that means they get a loan from someone and uses the proceeds from that loan to pay the federal government back the balance on their student loan, right? So they're saying that people paying back their student loans will cost the paxpayers money? That makes no sense -- me paying the loan back means the taxpayers are no longer at risk for the balance of my loan.

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Some of the borrowers (for loans in the amount of x) default on their loan, and some (for an amount y) don't. Then you (where 'you' is the original lender) have on the books, under 'assets': (y + expected interest on y) - (x + expected interest on x). You don't know for sure yet how many will default, of course; but you can predict something from the socio-economic makeup of the borrowers.

Now, y gets smaller because some people pay off their loans in one go, to refinance somewhere else (the whole presumption is that only those who won't default will refinance); the expected interest becomes zero. But x stays the same. So y - x gets smaller. Hence, your number in the 'assets' column gets smaller; a write down that is counted as a 'cost' at end of year. You do get y in the assets column (the money that is paid back), but without the expected interest.

In other words: non-defaulters will keep serving their debt, earning the lenders interest. Defaulters have to be written down, including the interest. The less non-defaulters there are, the worse the overall portfolio will perform. If you estimate a performance of x at year t, and in year t + 10 it turns out that you need to revise the performance to (0.8 * x), then that 20% is a write down - i.e. a cost.

Worth noting that this is probably a less catastrophic write-down than a private lender would face in the same scenario, as these loans typically can't be discharged and the federal gov't can do all sorts of crazy things to recoup money on a default (garnish wages, taxes, etc.).

But y does not get smaller. Only expected interest on y gets smaller. y is the same (actually a little larger because money today is worth more than money tomorrow) and in the governments pocket. If the government was smart they would put the y in their pocket to use to offset the risk of x.

You're right, I didn't write it exactly enough. What gets smaller is (y + expected interest on y) because the expected interest goes to 0.

The whole thing to realize here is that the 'cost' is not an actual loss as in 'less money comes in'; it's a cost in the sense of 'this portfolio will perform less than we anticipated'. And if the interest that people pay is based on a certain overall performance, but now all of a sudden the performance needs to be adjusted downwards, then one might argue 'we were shooting for a 0-operation, but in the end we will have to spend money to make up for the good borrowers leaving'.

Here's another intuition that explains it: if the market is willing to finance the good borrowers at half the rate it takes to lend to everybody, regardless of their prospects of paying back; then only the bad borrowers will stay in the government-funded portfolio, reducing the performance that was originally estimated. Which is, if you've accounted for future earnings based on the original estimate, a loss when you have to write it down.

But taxpayers are also unable to profit on any future accrued interest for your loan. Also, the people who are getting refinanced aren't typically high risk to begin with. So the government loses the low-risk interest, creating a riskier pool of investments that yields less interest overall.

So would you say that someone deciding not to take out a student loan at all also "costs the taxpayers money"?

No, but that's not relevant in a discussion of accounting/investment in this case. Here, what's happening is the government gets a commitment from a certain number of people, and well understood actuarial math tells them how many are likely to pay back, how quickly, etc. They then take all that combined with the interest rates and principal amounts, bundle it up into a number, and say "here's the money we will make." That gets used elsewhere in the budget to understand the flow of money, and AFAIK is very widely accepted as a valid accounting practice. (Side note: for an instance of where this went really haywire, look at the 07/08 crash where the math was fudged and we did not understand how much money was coming back from loan investments)

The problem is not "oh noes people are paying us back" it's "well crap, the private sector is undercutting our legislatively defined interest rates and we will be vastly under target on these returns."

If the government never "had" the money (again, in the accounting sense, loan payments are pretty stable investments normally), then they can't lose it (as in your counter-point). However, if they did "have" the future money (in the accounting sense), and they can no longer expect that to come in, they are in fact losing money (again, on the books). In these cases, there's no actual dollar bills flying out of the window, just some accounting projection spreadsheets somewhere that make people unhappy.

Well, it seems the actuarial math should include projections for people paying off their loans early just like they include projections for defaults, etc, and if you demand an above-market interest rate, obviously you'll increase the likelihood that people find better deals elsewhere.

But what I'm really objecting to is the conclusion that the future loss of interest represents a loss of income, when they now have the principal back and can invest that in the currently best way possible. If what you get from those funds today is significantly worse than the projected income from those loans were, then it seems you are implying that student loans really are meant to shaft the people who take them out.

If you take out a car loan or mortgage, the bank (or credit union (or government)) expects to make money off your interest for the next 5 to 30 years.

If you pay off your loan/mortgage early then the bank won't get all the future interest it expected to make — the bank only made [START, PAYOFF] interest instead of [START, FULL-TERM] interest. Some loans even have "pre-payment penalties" to favor the bank over the consumer in such cases.

Sure, but they now have the money back and can lend it again, which may even work to their advantage if interest rates have risen since the loan was signed. It seems impossible to me to say that the net effect is a sure loss.

And that's entirely beside the point that "not making as much money as I had hoped" is not the same thing as "lost money".

"not making as much money as I had hoped" is not the same thing as "lost money".

It depends on how you account for it. Technically you shouldn't assume all your future interest is materialized (IANAA), but if you run forecasts and see you have a million people who owe you a billion dollars total on a 7% interest rate over the next 20 years, you expect to have, within reason, that money.

If something incredible happens and all those people suddenly pay off their loans this month, that drastically changes your future (especially if your loans were at a higher interest rate from the past you can't re-charge today).

But you are still a billionaire so I won't be shedding any tears for you.

It seems to me that if early repayment of a loan is disadvantageous enough to require a penalty, the interest on the loan was unreasonably high to begin with. Out of proportion with the risk the bank is running, and out of proportion with the ROI they could normally get out of that money.

Maybe we should take pre-payment penalties as a sign to negotiate a lower interest rate.

The article's argument is that only people who qualify with the lender have the opportunity to pay it back. That will remove the successful wealthier debtors and leave the ones more likely to default.

Agreed. The only thing I can think of is that perhaps the interest payments on loans to low-risk borrowers subsidize the loans to high-risk borrowers who default.

My reading of the article is that the interest gains from more creditworthy borrowers help offset losses from loan forgiveness and defaulting borrowers.

It's because The federal govt is making a nice profit off these low risk borrowers, which in turn subsidizes the high risk borrowers. Lose the low risk borrowers from your portfolio and your overall expected return drops. In more concrete terms the Kellogg MBA in the article was paying the govt 6.5% interest, but the free market would do the deal for less than half that.

What's happening is that lenders are saying "we'll pay back your loan and offer you a lesser interest rate". So they pay the government the 200,000 you owe at 6.9% APR and then send you a bill for the 200,000 with a 4.4% APR. The USG loses all the interest since everything is paid back immediately and these lenders pocket your 4.4% APR. It seems like a win win win for everyone since the government gets paid back everything, the student has a lower interest rate, and the lender pockets the 4.4% annually but when there are so many lenders doing this it essentially cheats the USG out of all interest they'd earn on these loans.

Yeah, but the 6.9% interest the government is asking is ridiculously high for a student loan (which is still an investment in the future of the country).

The government not wanting to fund education is bad enough, but trying to profit from it with loan-shark level interest rates is insane.

Oh yea you're telling me haha. I'm with you on that all the way.

Again, worth noting: there is no risk to the taxpayers for the balance of your loan. You cannot discharge student loans through bankruptcy, and the government can garnish your wages, tax refunds, and social security to repay them.

But you can still discharge them through death, can't you? So there's still risk of non-repayment, if the borrower stays poor until his/her death.

The balance of the loan is different from what you (as a lender) have to put the loan on the books for. Even if there is no way to legally discharge it, if it's unlikely that the loan will be paid back (or part of it), you have to value it for the amount you expect to receive.

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