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The Department of Education recently published a series of performance summaries for its Federal Direct, Federal Family Education and Perkins student loan programs. A little more than $1.2 trillion is due from roughly 42 million students, who owe an average $29,000 each.

The most comprehensive of these reports pertains to $855 billion in Federal Direct loans, of which $440 billion is in routine repayment. That’s “routine” in that it excludes loans in deferment, forbearance or default, yet 15%, or $66 billion, of the remainder are 31 or more days past due. That’s a horrendous statistic, particularly for a “scrubbed” portfolio like the one just described, and considering the delinquency rate for credit card balances — i.e., debts that are comparably unsecured, or uncollateralized — stands at 2%, plus a little decimal dust.

It also significantly understates the extent of the problem.

Of the $88 billion in deferment, $12 billion represents loans to borrowers who are currently unemployed or suffering other economic hardships; another $97 billion of loans are in forbearance, $56 billion are in default and $6 billion are characterized as “other.” That’s another $171 billion in past-due debt, which, when added to the aforementioned $66 billion of past-due accounts in the “routine” portfolio segment, amounts to $237 billion out of an adjusted total of $611 billion ($440 billion plus $171 billion).

In other words, nearly 40% of all Federal Direct loans qualify as troubled debts of varying degrees.

That doesn’t even take into account the increasing number of loans being granted relief under the government’s various income-based repayment plans, such as IBR and Pay As You Earn (PAYE). If not for that support, the delinquency rate could very well soar by an additional 10% to 20%.

Clearly, it’s a public and private sector engendered fiasco. The only logical course of action is to break apart the problem: address the loans that have already been made, and revamp the program going forward.

A portfolio in which nearly half the loans are past due, in default, deferred, in forbearance or require significant restructuring is one that was improperly conceived. Although it makes a certain degree of sense to link installment payments to household income (as the government is now doing), the process is awful: The onus is on individual borrowers to ask for and ensure they receive the help they need, year after year.

What I’ve just described is the definition of a portfolio that’s “managed by exception” as opposed to one this is “actively managed.” It’s the difference between waiting for the phone to ring instead of making the call in the first place.

Given the magnitude of the problem, the government has no choice but to restructure all existing contracts by extending repayment durations and adjusting interest rates to the current rate for new Federal Direct loans.

Doubling Loan Terms: A First Step

Specifically, the standard 10-year (120 months) loan term should be doubled to 20 years (240 months) for loans in repayment, less twice the number of monthly payments that have been made to date (since we’re talking about doubling the original duration). Borrowers should also have the right to accelerate their loan at any time without incurring a penalty.

For example, suppose a student accumulated $30,000 in debt with a 6.8% interest rate. The monthly installment comes to $345.24. Also suppose the student commenced his repayment two years ago. At this point, his balance would be $25,508.

Now let’s take that balance and spread it out over an additional 192 months (240 months less 48 months, which represents twice the 24 months that have been repaid) and finance it at the current 4.29% rate for Federal Direct loans. The monthly installment would be nearly halved to $183.36.

And should this borrower have the ability to continue making payments at the original amount of $345.24 per month, the reduced interest rate would cause his repayment term to contract to 74 months instead of the originally remaining 96 months.

No more pandering for relief, no more follow-up calls to confirm it was done correctly, no more marking the calendar for annual requalification. Not only would rates of delinquency, default, deferment and forbearance decline because the payments would become more affordable, the government would save money with subcontractors paid large bonuses for remediating problems caused by misguided loan structuring at the start.

Now, to address the program going forward, a 20-year repayment term is just the first step.

How to Make Better Loans Moving Forward

Loan approvals should be based on projected post-graduation financial capacity. Routinely reported average starting-salary levels for recent graduates could be used for this purpose. Also, the ability to discharge education-related debts in bankruptcy should be restored, if only to disabuse public-sector policymakers and private-sector lenders of the notion that student loan borrowers have no choice but to repay however much debt they saddle them with.

Finally, at whatever point the government decides (or is compelled by Congress) to begin divesting the immense amount of Federal Direct loans on its balance sheet, it should do so as principal rather than through private-sector intermediaries. By that I mean as long as the government continues backstopping these loans, it is entitled to dictate standards for transactions moving into the private sector. In particular, the must ensure financially distressed borrowers are identified early and dealt with forthrightly, wherever these divested contracts end up. Anything less will put taxpayers at risk.

At that point, our attention should turn to the reason we have this problem in the first place: the price of tuition.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

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