Student loans operate very strangely in this country. A student borrows money from the federal government to pay for higher education expenses—thus, there are three parties involved (the student, the government, and the college or university). But only two of them face any risk from the loan. The student faces severe financial consequences if he defaults, such as a damaged credit score, making it difficult and expensive to get a loan for a house or car. And the government stands to lose a lot of money if the student doesn’t repay (the best estimate right now is that the government loses 24 cents of every dollar it lends). But the school doesn’t face any risk at all. It gets paid up front and keeps all the money, regardless of whether the student defaults or if the government is repaid.
Needless to say, this system gives colleges and universities skewed incentives. Institutions are financially rewarded for offering programs to students who don’t benefit from them. Maybe the program is low quality; maybe the students were too academically unprepared to succeed; or maybe the labor market simply doesn’t compensate the program’s knowledge and skills enough to justify its costs. Any of these should be a giant red flag that warrants phasing out a program, but from the school’s perspective, none of that matters if students are still enrolling. Institutions are rewarded for enrollment, not student success.
Thus, for colleges and universities, student loans are a “heads I win, tails you lose” proposition—they win no matter what. That should change, and one promising idea was pioneered by the schools themselves: Loan Repayment Assistance Programs (LRAPs).
Under LRAPs, an institution essentially offers students insurance for their student loan payments by repaying the loans when the students cannot. For example, if a student owes $300 a month in student loan payments, but can only pay $200, the school pays the remaining $100.
Some colleges and universities are already voluntarily using LRAPs because it allows them to inflate their prices. How can helping students make loan payments end up being a financial boon for the institution? Because of loan forgiveness.
The loan forgiveness provisions in income-driven repayment programs forgive loans after students make payments (based on their income, not their debt) for 10 to 25 years. If the school’s price is high enough, it will gain more from the high level of debt used to pay tuition (most of which is forgiven) than it spends helping students make payments for several years. In other words, a college or university can help a student make several thousand dollars of payments, and, in return, it gets to keep tens or hundreds of thousands of dollars from inflated prices. This strategy works best for high-priced programs with low earnings (relative to debt), like law school. In fact, many law schools offer LRAPs.
One way to fix student loans is to build on the LRAP idea. While current LRAPs are voluntary and shift the cost of forgiven loans to the taxpayer, the new LRAP would be mandatory and require the school to pay for any forgiven student loans. This essentially makes the college or university a co-signer on the loan.
Mandatory LRAPs would have a variety of beneficial effects.
First, they would completely eliminate student loan defaults. Since the institution would have to repay any debt the student doesn’t, there would be no more defaults on student loans.
Second, they would align schools’ incentives with the interests of students and the government. Under the current system, the college or university still wins financially even if the student and the government lose. But under mandatory LRAPs, schools would only win if students and the government win too.
Third, they would lower student loan debt. Right now, institutions face no financial consequences when their students accumulate excessive student loan debt. But under mandatory LRAPs, colleges and universities would be on the hook for that debt, and would therefore restrict student borrowing.
Fourth, they would likely lead to shifts in enrollment patterns. Schools would downsize or close many high-debt / low-earnings programs, while establishing and expanding low-debt / high-earnings programs. This would benefit students by making enrollment less financially risky.
In sum, mandatory Loan Repayment Assistance Programs offer a promising way to fix student loans.