President Biden’s student loan forgiveness plan is an unprecedented executive act. The plan to forgive up to $10,000 in student debt per individual earning $125,000 or less will cost taxpayers $240 billion over the next 10 years. It is obviously 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 percent between 1995 and 2017. This virtually unlimited increase in student loans led to a sharp rise in the price of higher education: Tuition at public four-year colleges doubled with you grow during the period. One would think that instead of simply applying a short-term solution to the student problem, the president would want to reverse these trends to reduce both tuition and debt for the next generation.
The good news is that we can still do it with a simple reform: we need to start requiring down payments on federally backed student loans.
In the financial industry, down payment requirements are extremely common. For example, most borrowers must pay a portion of the purchase price out of pocket to purchase a home. Lenders sometimes require down payments on auto and RV loans. Why should it be any different for buying an education?
Down payments serve several purposes. Most obviously, they lower the risk for the lender. The higher the down payment, the lower the risk of delinquency and default. The 90-plus-day delinquency rate on federal student loans is nearly 5 percent, which means the government is lending money to lots of people, in the range of 2.17 million borrowers, who can’t or do not want to make their payments. .
Down payments are also good for the borrower: By putting down some money, borrowers reduce their chances of default, reduce the principal balance on the loan, and pay less interest.
Wait, you might say, don’t down payments make buying a house and getting into a car that much harder? Won’t they also act as a barrier, keeping people who can’t pay for their education up front from college?
The short answer is yes. Down payment requirements limit who can receive loans in the first place. But from another perspective, they would decrease the inflated demand for college degrees. Is that so bad?
If students had to pay cash for a portion of their tuition, fewer people would earn college degrees, either because they can’t afford it or because, as a matter of personal preference, they decide it’s simply not worth the cost. The simple operation of the Law of Supply and Demand would lead to a drop in demand and a corresponding decrease in the cost of tuition.
So what would a student loan down payment plan look like? Suppose someone wants to attend a school that charges $10,000 in tuition per academic year, the average cost of in-state tuition at a public university. The student gets good grades and therefore receives $5,000 in scholarships, leaving 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 had to put down a 20 percent down payment, she would have to give the school $1,000 up front. She can then decide to attend a more affordable school (perhaps a community college) or simply drop out of college and enter the workforce right away.
Under our current federal loan system, she can receive a loan to cover 100 percent of her remaining balance. Whether she puts up money or not, the student will still have to pay $5,000, but the current system allows her to put off as much of the cost as she wants. And, since the government just set a precedent for forgiving student debt, she’d be a fool if she paid a dime of her own money.
By allowing the student to postpone the cost until they graduate, the current system encourages them to think less about comparative prices. As a result, you could choose to attend a much more expensive out-of-state school. What does she care if he 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 the decision maker will prefer a particular present good to the detriment of their future self. Requiring the student to pay a down payment would make the real cost more immediate for her. A down payment on tuition remaining 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 university.
Of course, some students will not be able to afford to attend their desired school if they are required to make a down payment. As sad as it is, requiring down payments has many benefits for society and for students. Restricting student loans in this way would stop the cost of tuition from rising, making it more affordable for those who really want to go to school. And because they won’t be able to get as much financing, students will be saddled with less debt.
Requiring students to make down payments for their college expenses would not be popular; necessary political reforms often are not. But if we’re serious about reducing tuition costs and student loan debt, we need to think outside the box. Having students pay for part of their education in advance is one way to achieve both ends.