President Obama is planning to change the ways that students obtain loans, with more funds coming directly from the government rather than through subsidized lending. But the fundamental issues surrounding college loans aren’t going to change. They are worrisome.
If you are a taxpayer, you might be surprised at how generous the government is in providing loans and how lax about repayment. If you are a student, you should know that government policies change your incentives: they encourage you to borrow more than you should, to hold on to the loans for years without repaying them, and even to enter jobs that you wouldn’t otherwise have picked.
Just like the credit card companies that many people are up in arms about, the federal government is teaching our young people to “buy now” rather than work or save. In fact, since college loans typically reach tens of thousands of dollars, their effects are much worse than those of credit-card debt.
College loans are the easy-money alternative to saving and working for college. In a few cases, students will make money off the government, by stretching out low-interest loans for years—a bad deal for the taxpayer. But in many cases, students themselves are encouraged—pressured, even—to abandon whatever their parents taught them about thrift and to make unwise choices that can affect their success and the direction of their lives.
Most college loans are subsidized by the government, and this fact is going to continue whatever policies Obama and Congress adopt. Subsidized interest rates—that is, rates that are lower than the prevailing rates for most loans—encourage students to borrow more money than they would under market conditions. Many students who graduated at the same time I did—in 2003—were able to lock in rates as low as 1.75 percent when they consolidated (that is, bundled) their loans. Getting a loan at a low interest rate is often a “good deal” for students. But most students would be better off graduating debt-free.
The average college senior leaves owing $19,237 in student loan debt, according to the 2003-2004 National Postsecondary Student Aid Study (NPSAS). This is a substantial sum for recent grads entering low-paying entry-level jobs. In many cases, even at low interest rates, their monthly payments would be enough to finance a car.
When students can get loans at interest rates that are lower than the rate of inflation, they are essentially being paid for borrowing money. It’s not surprising that those students leap at the chance. But not every graduate is lucky. When the time comes to pay off the loans, and graduates consolidate them—putting a number of loans together at a fixed rate—those rates are dependent on the economy at the time. Students who graduate during economic booms often end up with higher fixed rates. Graduates can end up paying many thousands of dollars of interest on their student loans by lengthening the repayment period.
One reason that graduates stretch out payment of their loans for years is the tax code. Taxpayers making less than $70,000 a year can deduct 100 percent of the interest on their student loans, substantially reducing the amount of taxes owed every April. Given such a generous deduction, it’s smart for students who have already taken out thousands of dollars in loans to take a long time to pay their loans back. But they would be better off taking out less in the first place. (See my earlier article, “How My Friends and I Contributed to the College Loan Crisis”).
Repayment options—such as those provided by the College Foundation of North Carolina (CFNC)—also discourage quick repayment. It’s all too easy to choose an option that reduces monthly payments but therefore lengthens the payment time and the total amount of interest paid. Students can choose between standard, graduated, income-sensitive or extended repayment plans. Some borrowers take as long as 30 years to pay off student loans—a length of time long enough to pay off a mortgage. Wiser choices from the start would enable a graduate to put this money into a mortgage, not college.
Furthermore, students can put loans into deferment or forbearance while they attend graduate school or are unemployed. Those options allow students to put off indefinitely paying loans or accruing interest. To some degree, such generous policies discourage students from leaving graduate programs or seeking gainful employment. Perhaps that’s why it takes ten years, on average, to get a Ph.D.
Other federal laws drive students who have borrowed money into professions they wouldn’t otherwise choose, such as teaching, certain non-profits, and public service. That is because, under certain circumstances, the federal government will cancel all or part of an educational loan. To qualify, students must perform volunteer work, perform military service, teach or practice medicine in certain types of communities, or work in public service careers. These are considered socially useful jobs, so the public doesn’t object. But in reality the public is turning a blind eye to the fact that the government is directing graduates into jobs they might not otherwise choose.
Most of the public service jobs included in these forgiveness programs are government positions, where graduates will continue to feed at the public trough. The only exceptions are some 501(c)(3) organizations and public interest legal services.
Such a law discourages some or many students from entering fields that they love—but in which they would have to pay off their debt. It also discourages students from thinking of their loans as “real money”—why should they, if they will be wiped away by the federal government within a few years of graduation? Furthermore, these policies encourage savvy and unscrupulous students to dupe the taxpayers by working for the requisite number of years in a certain field exclusively for the debt forgiveness, then leave that field after their time is up.
To these current incentives, which lead to government-pressured career management, President Obama is expected to add more. He is likely to announce a loan forgiveness program as part of his National Service Bill. Such a plan would drive even more students into volunteer work and public service rather than into careers of their own choosing. An Obama supporter described the program as “a way for college students to give back and get out of debt. You’ll be able to volunteer and get credit for up to $10,000 worth of loans per year.” Besides the obvious objection that volunteer work, by definition, shouldn’t be paid, this creates the additional problem that the government, instead of individuals, can decide what kind of volunteering is worthy.
All of these market distortions send students the wrong signals. They lead students into more debt, and for a larger portion of their lives. They strip students of the will to make decisions about their own future by imposing government’s views of the best jobs and charities. They also teach students that college’s purpose is to fill particular job quotas, rather than to provide them with a solid education, love of learning, and a foundation of knowledge. Student loans should be governed by policies that allow students to make the best decisions possible instead of policies that help to fill government jobs and encourage student debt.