Can private investors solve the student loan problem?

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November 7, 2015

Marco Rubio’s proposal for asking students to turn to private investors to get the funds they need to pay for college, rather than borrowing through the federal government, is getting renewed attention. The “Student Investment Plan”—labeled “income share agreements” in the Urban Institute’s overview of 2016 higher education campaign issues and sometimes called “human capital contracts”—would, according to Rubio,  “give students the option of paying for their education without acquiring any student loans at all.”

The idea is that investors would pay students’ tuition in return for a percentage of their incomes for a set period of time after graduation. The availability and terms of the non-loans would depend on students’ major, institution, school record, and other factors related to the likelihood that they would find good jobs and make high payments. The obligation would be for a fixed percentage of income for a set number of years, regardless of how the total payments added up over that period of time.

This plan could work out well for some students, especially those who expect their earnings to be lower than they might appear to an outside observer. But investors in these programs would no doubt expect to make a profit. Students would be supplying that profit. And it’s not clear in what sense the proposed system would be less risky for students than existing federal income-driven repayment plans that forgive remaining balances after 20 or 25 years if borrowers’ incomes are not high enough to support repayment of the entire debt.

For most students—and particularly for those for whom postsecondary education is their best hope for moving up from relatively humble beginnings—this plan would surely be worse than existing federal loan programs. A student in the final year of an engineering program at MIT would be funded with the expectation of a lower percentage of income and/or a shorter number of years of repayment than a community college student working toward an associate degree in phlebotomy or a student studying social work at a regional public university.

Among dependent four-year college students in 2011-12, the percentage enrolled in highly selective institutions ranged from 11 percent among the lowest-income quartile to 27 percent among the highest income group. Among students from families in the highest family income quartile, 51 percent attended doctoral universities and 26 percent were enrolled in public two-year colleges.

In contrast, among those from families with incomes below $30,000, 29 percent attended either public or private nonprofit doctoral universities and 41 percent were enrolled in public two-year colleges.

It is highly unlikely that low-income students would get the same favorable terms on their non-loans as higher-income students.

Perhaps most worrisome is the suggestion that this strategy eliminates loans. Like the short-lived Oregon Pay It Forward idea—where college would be “free” and students would have “no loans” but would pay a percentage of their incomes after finishing school—this plan gives loans a different name and pretends the problems are solved.

We do need to discourage over-borrowing for institutions that don’t serve students well. But relying on onerous borrowing terms to discourage at-risk borrowers is likely to make the situation worse. Insights from behavioral economics and the cognitive sciences make it clear that just modifying the cost/benefit ratio of a particular postsecondary choice is unlikely to be adequate for improving the decisions students make. And first-generation students, for whom the decision is most complicated and mysterious, face the biggest challenges.

The federal student loan system was designed to provide credit on reasonable terms to individuals without credit histories or collateral to give them the opportunity to invest in themselves through postsecondary education. We should be coming up with better ways to guide students to productive educational pathways rather than obscuring the reality that they are borrowing money they will have to repay.

(Full disclosure: earlier this year, I advised the Clinton campaign on the development of the candidate’s higher education plan. Urban scholars are willing to provide evidence-based counsel to any campaign that seeks it.)

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