President Biden’s student loan forgiveness plan is an unprecedented executive act. The plan to cancel up to $10,000 in student debt per person earning $125,000 or less will cost taxpayers $240 billion over the next 10 years. This is patently unfair; it’s probably illegal; but worst of all, it does nothing to address the root causes of the student debt problem.
Total federal student debt increased by nearly 650% between 1995 and 2017. This virtually unlimited increase in student loans has led to a sharp increase in the price of higher education: tuition at four-year public universities has increased than doubled over the period. You would think that instead of just slapping a short-term solution to the problem for students, the president would want to reverse these trends to reduce both tuition and debt for the next generation.
The good news is that we still can with a simple reform: we need to start requiring down payments on federally guaranteed student loans.
In the financial industry, down payment requirements are extremely common. For example, most borrowers must pay part of the purchase price out of pocket to purchase a home. Sometimes lenders require down payments on loans for cars and recreational vehicles. Why should it be any different with the purchase of an education?
Deposits serve several purposes. Obviously, they decrease the risk for the lender. The larger the down payment, the lower the risk of delinquency and default. The 90+ day delinquency rate on federal student loans is nearly 5%, which means the government is lending money to a lot of people — in the range of 2.17 million borrowers — who unable or unwilling to make their payments.
Installments are also good for the borrower: by putting money aside, borrowers lower their risk of default, reduce their loan principal balance, and pay less interest.
Wait, you might say, don’t down payments make buying a house and buying a car that much harder? Won’t they also act as an obstacle, preventing people from going to university who cannot afford to pay for their studies in advance?
The short answer is yes. Down payment requirements limit who can receive loans in the first place. But from another perspective, they would reduce the inflated demand for college degrees. Is this such a bad thing?
If students had to pay cash for part of their tuition, fewer people would go on to college, either because they can’t afford it or because, out of personal preference, they decide it’s not worth it. just not worth it. The simple operation of the law of supply and demand would result in a decrease in demand and a corresponding decrease in tuition fees.
So what would a student loan down payment plan look like? Suppose someone wants to attend a school that charges $10,000 in tuition for one academic year – the average cost of tuition in the state at a public university. The student gets good grades and thus gets $5,000 in scholarships, which leaves her with $5,000 to cover. Under a hypothetical reform, she (or her parents) would have to contribute a certain percentage of the net cost. So if the student were to deposit 20%, she would have to give the school $1,000 up front. She may then decide to attend a more affordable school (perhaps a community college) or simply drop out of college and immediately enter the workforce.
Under our current federal loan system, she can receive a loan to cover 100% of her remaining balance. Whether she saves money or not, the student will still have to pay $5,000, but the current system allows her to defer as many fees as she wants. And, given that the government just set a precedent for canceling student debt, she’d be foolish to pay a penny of her own money.
By allowing the student to defer the cost until she graduates, the current system encourages her to think less about comparative pricing. As a result, she might choose to attend a much more expensive out-of-state school. What does it matter to her if she won’t have to pay a dime for years – if ever?
In this example, the student exhibits a present bias, a psychological tendency in which a decision maker will favor a particular present good over their future self. Requiring the student to pay a deposit would make the actual cost more immediate for her. A down payment on the remaining tuition after scholarships at an out-of-state school would likely be much higher. This differential would reduce her current bias, ensuring that she will be more price sensitive when choosing a college.
Of course, some students will not be able to afford to attend the school of their choice if they have to put money aside. As sad as it may sound, requiring deposits has many benefits for society and for students. Restricting student loans in this way would stop rising tuition fees, making them more affordable for those who really want to go to school. And because they won’t be able to get as much funding, students will be less in debt.
Requiring students to make installments on their university expenses would not be popular; necessary political reforms are often not. But if we’re serious about reducing tuition fees and student debt, we need to think outside the box. Having students pay for part of their tuition up front is one way to achieve both goals.