Student Loans Are Not Financial Aid

A couple of weeks ago, my colleague Erin Dillon wrote a short policy brief about student loan default rates, pointing out that they're far higher than commonly-reported government statistics indicate, particularly for student of color, students who borrow a lot of money, and students who go into careers that don't pay very much. As college costs continue to skyrocket and students borrow more and more money, this under-recognized problem will become worse and worse. While the college cost / debt crisis has many origins, I think one source of the problem lies with language: Student loans are routinely characterized as "financial aid." They're really not.

Some background data: Over the last 20 years, tuition and fees at private 4-year universities (measured in enrollment-weighted, inflation-adjusted dollars) have almost doubled. At public 4-year institutions, they've more than doubled. Higher education folks are quick to point out that these figures don't include discounted tuition rates or alternate price deflators or the effect of Baumol's cost disease, and there's truth in all of these things. But trust me when I tell you that no matter how you look at it or what allowances you make, college is getting more expensive, period.

Obviously, this hits poor students the hardest. While need-based aid programs like Pell grants have increased in size, they haven't grown nearly as fast as the cost of college. The resulting gap has been filled largely with student loans. In 1992, the average student's grant aid was double what they borrowed; today loans exceed grants. In just the last ten years, the total annual amount of student loans has nearly doubled, from roughly $38 billion to $75 billion (also in constant dollars). The risk and consequence of student loan defaults have increased accordingly.

Colleges have gotten away with this for a lot of reasons. People like higher education, and there's really no alternative to getting a college degree. Plus, as we're often told, higher education pays, to the tune of $1 million in extra earnings over a lifetime. A few extra thousands dollars in debt seems to pale by comparison.

But there's also a subtle language game going on, whereby the higher education industry likes to talk about grants and loans as if they're the same thing. The College Board, for example, says "Today, loans are the largest form of student aid, making up 54 percent of the total aid awarded each year." This is typical, everyone in higher education talks about aid this way, as if loans and grants are just too different flavors of the same beneficent gift, student financial aid.

They're not. The only parts of student loans that are "aid" are the subsidized parts. This comes mainly in the form of reduced interest rates, with lower-income borrowers who receive subsidized Stafford loans also getting their interest paid while they're in school. How much is the subsidy worth? On average, in percentage terms, low single digits. Stafford loans come at a fixed interest rate of 6.8 percent. With a decent credit history, you can go into the private loan market and borrow at less than 10 percent. For people with good credit considering the PLUS loan program for parents of students in college, the 8.5 percent rate can be more expensive than what you can get on the open market. There are certainly some cases, like a low-income student with poor credit, where the subsidy is higher. But on average, we're talking pennies on the dollar. Which means that students aren't getting nearly as much "financial aid" as we tell them they're getting. They're just paying more for college, plus interest.

One of the reasons loans are described as aid is that historically the benefit was thought to be the availability of the loan. When the federal student loan program was created back in the mid-60s, there was no private student loan market to speak of, and the assumption was that nobody would lend money to students with no assets and credit history, particularly when they thing they were borrowing money to buy (a diploma) can't be repossessed if they default. But the rapid growth in the private loan market shows this is becoming less and less true. In 1997, private loans made up 6% of all student loans. That percentage doubled to 12% by 2001, then doubled again to 24% in 2007.

Now, referring to the total amount of the loan as aid--rather than the small fraction of the aid that is the subsidy--mainly serves to obscure the rising cost of college. You apply to college and wonder how the heck you're going to afford tens or even hundreds of thousands of dollars, and the college says "Don't worry! We will provide you with a financial aid 'package' to make up the difference between what we're charging and what you can afford." But more and more of that package is just a loan, which means the price of college is actually even more than the gut-wrenching price of tens or even hundreds of thousands of dollars you've been quoted, once you add the interest, never mind the opportunity cost of having your career decisions determined by the size of your monthly nut once you graduate.

It's time to call student loans what they are: debt, and little more.