Student Loan Forgiveness is No Solution to America’s Higher Education Cost Problem
The Biden Administration is reportedly contemplating the elimination of up to $10,000 worth of student loan debt for borrowers making less than $150,000 per year ($300,000 for married couples filing jointly). Merely forgiving these loans does nothing to address the rapidly increasing price of higher education, which is driven by three things: 1) federal subsidization of the market for higher education, 2) a lack of financial literacy among students graduating high school, and 3) lack of competition and accountability in the loan market.
Federal Subsidization of the Market for Higher Education
1970, the average American student graduated college with a grand total of $1,070 in student loan debt. If students continued borrowing at the pace of inflation, then the average student loan debt held at graduation today would be $7,973. Instead, the typical college graduate leaves school with $31,100 in total debt – a 390% increase after accounting for inflation.
The increase in costs can mostly be attributed to the widespread availability of loans from the federal government. Virtually any student of any background can obtain a student loan from the U.S. Department of Education – a perverse market incentive that encourages higher levels of borrowing. This is demonstrated by the fact that the Department of Education holds approximately 92% of the $1.75 trillion in student loan debt held today.
One area of this issue where state policymakers can help is through required financial literacy courses for high schoolers. To measure financial literacy in the U.S., the TIAA Institute-GFLEC Personal Finance Index (P-Fin Index) is often utilized. The P-Fin Index consists of 28 questions aimed at measuring a participant’s financial knowledge. The 2022 version of this report shows that Americans overall could only answer half of the test questions correctly, and Gen Z participants could correctly answer just 42%.
Despite this lack of knowledge in such a critical area, just seven states (Alabama, Mississippi, Missouri, North Carolina, Tennessee, Utah, and Virginia) currently require a stand-alone financial literacy course in high school (not including Iowa, Florida, Nebraska, Ohio, and Rhode Island which are implementing the requirement in the coming years). A handful of other states also offer financial literacy courses to students, but they are either offered as an elective or bundled into a different graduation requirement (i.e. students could be required to take consumer mathematics in order to graduate, and financial literacy is a small part of this overall course).
Too many students are graduating high school with a lack of understanding and exposure to important financial topics, including loans and interest rates. For example, a 2019 study from New York Life found that the average student loan borrower did not start making payments until the age of 26, resulting in an average 18.5 year pay off timeline. The goal of a financial literacy requirement in high school is to encourage better spending, saving, and investing habits down the line. Students not only gain a better understanding of how quickly interest can pile up on a loan, but they also learn the basics of saving for retirement, investing in the stock market, and more.
Lack of Competition and Accountability
Borrowers that complete the Federal Application for Free Student Aid (FAFSA) are assigned loan terms based on the information they provided. Instead, borrowers ought to be able to select a lender based on the best terms each can offer. If the borrower is given a list of five potential lenders with interest rates ranging from 2%-5% on the same amount of principal, then the borrower will choose the 2% rate. This encourages lenders to provide more favorable loan terms in exchange for the borrower’s business. Better yet, the U.S. Department of Education could be a competitor in this market offering loans at the 10-Year Treasury Rate (currently 2.74%) to further encourage more reasonable lending terms.
Another problem with the current structure of student loans is that they are very difficult to discharge in bankruptcy. From a lending standpoint, this means that you are assured payment even if the borrower suffers a financial hardship down the line. By making these loans dischargeable in bankruptcy, lenders would be more likely to offer favorable loan terms and take a closer look at a student’s ability to repay. For example, a student majoring in music would likely be considered a riskier borrower than one majoring in pre-medicine.
Lastly, there is little accountability for institutions of higher education with high rates of student loan borrowing and delinquency. Many colleges and universities are granted access to a student’s FAFSA data, which is then used to determine eligibility for merit-based scholarship awards and other forms of financial assistance. The FAFSA data also tells these institutions how much money they could expect from the federal government for a student’s tuition and fees, and the process for them to receive that money is very simple. Instead, institutions with high rates of student loan delinquency should be held to a higher and more accountable standard. Doing so would not only offer more protection for taxpayer money, but may even encourage colleges and universities to lower their costs and minimize the risk of borrowers defaulting down the line.
While $1.75 trillion is a massive amount of money owed in the student loan market, the reality is that this debt is held by just 16.67% of Americans over the age of 18. While forgiving these loans would certainly help those borrowers, five out of every six Americans would see no benefit from such a policy. This includes Americans who passed on an opportunity to go to college over cost concerns, those that worked hard to pay off their student loans, and those who may have chosen an alternative career pathway (i.e. technical, trade, and vocational schools) at a more reasonable cost. Rather than focus loan forgiveness on a limited group of borrowers, the federal government should be looking toward real solutions to solve higher education’s underlying cost problems.