President Biden’s student loan forgiveness plan is an unprecedented act of executive fiat. The plan to forgive up to $10,000 in student debt per individual making $125,000 or less will cost taxpayers $240 billion over the next 10 years. It’s patently unjust; 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 from 1995 to 2017. This practically limitless rise in student loans led to a steep increase in the price of higher education: Tuition at four-year public universities more than doubled over the period. You’d think instead of simply slapping a short-term fix on the issue for students, the president would want to reverse these trends to reduce both tuition and debt for the next generation.
The good news is we still can with one 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 need to pay a part of the purchase price out of pocket to buy a house. Sometimes lenders require down payments on loans for cars and recreational vehicles. Why should it be any different for the purchase of an education?
Down payments serve several purposes. Most obviously, they decrease the risk to the lender. The larger the down payment, the less risk of delinquency and default. The 90-day-plus delinquency rate on federal student loans is almost 5 percent, meaning that the government is lending money to a lot of people — in the ballpark of 2.17 million borrowers — that either can’t or won’t make their payments.
Down payments are good for the borrower, too: By putting some money down, the borrowers decrease their chances of defaulting, reduce their principal loan balance, and pay less interest.
Hang on, you might say, don’t down payments make buying a house and getting into a car a lot harder? Won’t they also act as a barrier, keeping people out of college who can’t afford to pay upfront for their education?
The short answer is yes. Down-payment requirements do limit who can receive loans in the first place. But from another perspective, they’d decrease the inflated demand for college degrees. Is that such a bad thing?
If students were required to pay cash for a part of their tuition, fewer people would pursue college degrees — either because they cannot afford it or because, as a matter of personal preference, they decide it’s just not worth the cost. The simple operation of the Law of Supply and Demand would lead to a fall 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 for an academic year — the average cost of in-state tuition at a public university. The student makes good grades and is thus awarded $5,000 in scholarships, leaving her with $5,000 left to cover. Under a hypothetical reform, she (or her parents) would have to put down a certain percentage of the net cost. So if the student had to put 20 percent down, she would need to give the school $1,000 up-front. She may then decide to attend a more affordable school (perhaps a community college) or simply forgo college and enter the workforce immediately.
Under our current federal loan system, she can receive a loan to cover 100 percent of her remaining balance. Whether she puts money down 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 pleases. And, given that the government just set a precedent for forgiving student debt, she’d be a fool to pay a cent of her own money.
By allowing the student to put off the cost until she graduates, the current system incentivizes her to think less about comparative prices. As a result, she might choose to attend a far 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 is exhibiting Present Bias, a psychological tendency in which a decision-maker will prefer a particular present good to the detriment of her future self. Requiring the student to pay a down payment would make the actual cost more immediate to her. A down payment on remaining tuition after scholarships at an out-of-state school would likely be much higher. This differential would reduce her Present Bias, ensuring that she will be more price sensitive when choosing a college.
Of course, some students won’t be able to afford to attend their desired school if they are required to put some cash down. As sad as that may be, requiring down payments has many benefits for society and for the students. Restricting student loans in this way would arrest the rising cost of tuition, 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 on their college expenses would not be popular; necessary policy reforms often aren’t. But if we’re serious about reducing tuition costs and student loan debt, we need to think outside the box. Making students pay for some of their schooling up-front is one way to achieve both ends.