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Rubio: A vision for reforming student loans

This month, high school seniors across the country are receiving acceptance notices from colleges and universities. They will now confront the challenges of financing their higher education plans, and the decisions they make today will determine what kind of personal debt burdens they will have in their twenties and beyond.

Student debt has become a significant barrier to achieving the American dream. With outstanding debt topping one trillion dollars and the default rate on federal loans approaching 15 percent, many borrowers are finding themselves in a spiral of debt and financial ruin. This week, the Federal Reserve announced that American consumer debt is higher than it's ever been, with student loans leading this surge. This has serious long-term implications for our economy and a whole generation of young Americans.

How should we approach a solution? It's helpful to break the discussion into two parts: First, our repayment system for federal loans is broken, causing untold numbers of defaults. Second, we must implement reforms to lower college costs while improving quality.

It's important to note that a significant number of borrowers default on small debt levels. In fact, the average amount of a defaulted federal loan is roughly $14,000. Many of these defaults occur because our system focuses the burden of repayment on a borrower's initial years out of school when he or she is least equipped to bear it. As a result, temporary struggles to find a job right out of college or low initial earnings turn into needless defaults. And while other options exist, the system's bewildering complexity prevents many students from taking advantage of them.

Far better would be to have each borrower's payments set automatically as an affordable percentage of income. For most, this would mean paying less early in their careers and more as their income grows over time. Additionally, borrowers would be protected from income shocks such as unemployment, something many recent graduates have struggled with during the economic downturn. It's a small fix that would make a big difference.

President Obama has talked about similar ideas through his "Pay As You Earn" plan. However, his focus has been to expand loan forgiveness while doing little to address the confusing bureaucracy that causes so many borrowers to fall through the cracks.

This approach is fundamentally wrong and will only reward over-borrowing while leaving taxpayers holding the bag. Instead, young workers need a streamlined and dynamic repayment system that automatically adjusts to their ability to pay over time. This would protect them from the financial ruin of default but in a way that is fiscally sustainable, fair and that encourages prudent borrowing.

Second, in addition to reforming our repayment system, we must attack the burden of debt directly by improving the quality of higher education while lowering its cost.

To do this, we should embrace innovative financing tools that would better serve students and bring market forces to bear on the higher education system. One promising idea, originally proposed by Milton Friedman and discussed in a recent report published by the American Enterprise Institute, would have investors provide students with money for school in exchange for a percentage of their income for a set period of time after graduation.

These income-share agreements would have no principal balance to repay, so a graduate whose educational investment does not pan out or who ends up in a less lucrative field than anticipated could end up paying less than the original amount provided. Also, because graduates are simply paying an affordable percentage of their income over the specified time period, they are protected during periods of low income. Investors would also have strong incentives to provide students with support and mentorship during and after their studies, something particularly beneficial to low-income students who often struggle to navigate the higher education process.

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