Why Student Loans Are Actually a Good Thing
Progressives and conservatives aren’t inclined to find common ground on much these days, but there is one topic where a consensus is emerging – and that might actually lead to bad policy. Both sides believe the country has a student debt problem, though disagree on a solution. Many progressives favor debt forgiveness or free college; many conservatives want the government to stop making loans that they say cause price and degree inflation, or they want the government to impose strict standards on which degrees qualify for loans. But both sides imply that student debt – and the federal loan program in particular – are fundamentally flawed.
The evidence on educational loans, however, is telling us something different - that the use of student loans helps students earn a degree and pay down their debt – and that some students would benefit from taking out more loans. These studies tell us that the original rationale for government-issued student loans is sound. That is, the private market is unlikely to provide students with loans at affordable terms for a number of reasons (i.e. they can’t be collateralized, information about creditworthiness is hard to obtain), yet the education that the loans make possible tends to be a good financial bet for students. Put another way, students are usually better off with loans than without them, everything else being equal. Private lenders won’t take that risk, however, at least not on a large scale at affordable terms for students. Absent a government program, then, a lot of good educational investments won’t ever be made.
One way that researchers can see the positive effects of government student loans is by comparing outcomes among students at colleges that don’t offer them and those that do. Some community colleges opt out of the loan program because too many students defaulting could result in federal sanctions that would cut off their students from not just loans but also the federal Pell Grant. Researchers studied this natural experiment in one Southern state during the 2000s, after a set of community colleges opted out of the federal loan program. They found that students did indeed decrease their borrowing at these newly non-participating schools, but also completed fewer credits in their first year, particularly in math and science classes. More recent work found that an increase in the maximum federal loan limits in 2008 and 2009 led students to borrow more, increased bachelor’s degree completion rates, and led to significant long-run improvements in earnings. Importantly, borrowing more did not hurt borrowers’ overall financial situation or result in increased defaults, and had no effect on homeownership rates.
Another study in one large community college showed similarly positive results but relied on a more intentional experiment. In a randomized trial, two groups of students who were both eligible for federal loans were given different suggestions: one group was offered no federal loans in their financial aid award letters – though could opt-in to receive loans if they took additional steps – whereas the other group was offered $3,500 as the default amount. The researchers found that students offered loans in their financial aid letters were, not surprisingly, 40% more likely to borrow, and just like the other study, there were positive effects associated with taking out more loans. Borrowers had higher GPAs, completed more credits, and were more likely to transfer to four-year colleges.
Both of these studies suggest that loans may be good in general, but they don’t necessarily refute the popular narrative that students are overborrowing and need to be more thoughtful about how much they take out. That’s where another study comes in. Based on the theory that students make suboptimal decisions about how much to borrow, researchers provided randomly assigned community college students with counseling that was supposed to help them make more “informed and active borrowing decisions.” Students reduced their borrowing as a result, perhaps offering evidence to support the overborrowing theory. However, these students also performed worse academically by failing more courses, which led to lower GPAs and credits earned. They also went on to default on their loans at much higher rates. The lesson here is that while the goal of reducing debt is admirable, it must be taken with care, lest it ultimately reduce the likelihood students earn a degree and make it even harder to pay back that debt.
To be sure, these findings don’t mean that student loans are always the right approach to paying for a higher education or that more debt is always better than less. First and foremost, these studies focus mostly on short-term effects for undergraduates, and all took place in public institutions. There are no studies using similar methodologies that focus on other types of colleges or graduate students. That said, there is some evidence to suggest that students at for-profit institutions may not benefit from additional debt. A recent study finds that almost all the concerning increase in default rates over the past few decades have been driven by “high-default” postsecondary institutions, predominantly for-profits.
Second, these results cannot tell us whether student outcomes might be better or worse under a completely different policy, such as “free college” or mass loan forgiveness. Nor can they tell us if those policies would be worth the added costs.
Even with those caveats in mind, the evidence argues for policymakers to exercise caution when pursuing student loan reforms. Policies that proceed from the belief that student debt is always harmful risk leaving students worse off in the end.