The Case for Private Student Loans

COMMENTARY Education

The Case for Private Student Loans

May 23rd, 2017 2 min read
COMMENTARY BY
Mary Clare Reim

Policy Analyst

Mary Clare is a Policy Analyst at The Heritage Foundation.
Most everyone agrees that college costs too much. But what can be done about it? iStock

Key Takeaways

A growing body of evidence suggests that federal policies aimed at making college more affordable have actually made it more expensive.

The federal government now controls over 90 percent of all student loans.

The private market is better than the federal government at adapting and innovating to meet consumer needs.

Most everyone agrees that college costs too much. But what can be done about it?

To answer that question, we must first understand why tuition is so high. A growing body of evidence suggests that federal policies aimed at making college more affordable have actually made it more expensive.

Consider this: The federal government now controls over 90 percent of all student loans. Moreover, Obama-era lending policies gave students virtually unlimited access to federal loan programs.

Colleges realized that this arrangement meant they could raise prices without losing students. The result: an explosion in tuition costs and student loan debt. The latter now totals $1.3 trillion.

Part of the solution, then, lies in turning off the spigot of federal student aid. Another part lies in the emergence of a thriving private-lending market.

Critics of privatizing student loans often argue that private lenders will lend only to students who present themselves as “safe” investments, turning away “riskier” low-income students. However, the private market has already started to answer this objection.

The American Enterprise Institute’s Andrew Kelly and Kevin James report that some private lenders have developed innovative risk assessment tools that take into account a student’s future earnings potential. This makes sense. A student loan differs greatly from a loan for a house or a car; it theoretically helps improve the client’s ability to repay.

Lending practices should reflect the uniqueness of student loans. The private market is better than the federal government at adapting and innovating to meet consumer needs. Its lending practices can easily adjust to reflect the distinct challenges and opportunities in student loans.

This can be helpful to students. For example, private lenders would consider important factors such as a student’s chosen field of study and academic history when deciding whether to grant a loan.

Currently, the federal government offers the same loan at the same interest rate to all students, regardless of what institution they attend or what they are studying. This gives the false impression that all educational paths are equally fruitful.

In a truly private lending market, student loans to pursue gender studies at an institution with a poor track record should come with a much higher interest rate than loans to pursue a degree in chemical engineering at MIT. After all, these factors have a great deal of bearing on a student’s future ability to repay.

The discipline of the market may encourage more students to gear their academic choices toward marketable skills.

There are a few ways that policymakers can help restore the private lending market and limit taxpayer exposure caused through federal lending. The first is to eliminate the costly PLUS loan program. This program allows graduate students and the parents of undergraduate students to borrow up to the full price of tuition. Evidence suggests that it is also one of the most egregious drivers of tuition inflation.

Second, policymakers should consolidate the five current federal loan programs into a single loan for students. Issuing this loan under the current terms of Graduate Stafford loans would be close to revenue-neutral, providing some much-needed protection for taxpayers.

The new consolidated federal loan should also come with both annual and lifetime caps on borrowing. This would put downward pressure on tuition, eliminate excessive borrowing and make space for private lending.

Finally, Congress should eliminate public-sector loan forgiveness. This policy, which forgives repayment of student loans of anyone who works in the public sector for 10 years, leaves taxpayers holding the bag for billions of dollars of unpaid loans. Costliness aside, the federal government should not be actively encouraging the growth of the government workforce.

These three reforms would significantly limit Washington’s role in higher education and make space for the private market to emerge. With Americans already struggling under the burden of $1.3 trillion in student loan debt, these reforms to ease tuition inflation can’t come soon enough.

This piece originally appeared in The Washington Times