It wasn't pretty, and advocates for students aren't happy with it. But after almost two years of fits and false starts, Congress on Wednesday passed legislation that would tie interest rates on federal student loans to the market and, at least in the short term, forestall hefty increases that were to hit new borrowers beginning this fall.
The legislation passed the House of Representatives by a wide margin (392-31, with 10 abstentions) after originating in the Senate, which approved it last week. The measure, when signed by President Obama, will reset interest rates on federally guaranteed loans each July based on the previous May's auction of 10-year Treasury bills. Undergraduate loans -- those that are federally subsidized as well as those that are not -- would be set at the Treasury rate plus 2.05 percentage points, while loans for graduate students would be set at 3.6 points above the Treasury rate, and loans for parents at 4.6 percentage points over the T-bill rate. The maximum rate would be capped at 8.25 percent for undergraduate loans, 9.5 percent for graduate student loans, and 10.5 percent for parent loans.
Parents: We can’t possibly afford $60,000 per year for our daughter to go to Medallion University.
College representative: But Medallion University provides financial aid based upon your family’s financial need.
Parents: Oh, that is interesting. Someone told me that Medallion University was need-blind, so I just figured you didn’t care if we couldn’t pay that much.
College representative: If your daughter is admitted to Medallion University, we will calculate your expected family contribution.
Parents: Well, we contribute to our church but we have never made a contribution to Medallion University, but someone told me this is expected in order to get in.
Should we laugh or cry about this exchange? While the conversation is written in English, the parents and college recruiter are not speaking the same language. The college representative is speaking the “Language of Financial Aid” while the parents are speaking a language about paying for college.
I call the former “Financial Aid Speak” and the latter “Payment Language.” To explain college pricing to the American public, higher education administrators must translate their rhetoric to Payment Language so families can make informed decisions about whether they can afford the price.
Actually, college administrators speak several languages in addition to Financial Aid Speak. Vice presidents for finance, for example, speak “Cost Language.” They engage in discussions about balance sheets and expenditures for producing a college education
Like Académie française for French, Cost Language has regulating boards that dictate the standards for word usage. The Government Accounting Standards Board (GASB) and the Financial Accounting Standards Board (FASB) regulate the meaning of words, phrases and concepts for finance administrators from the public and private sector, respectively. But administrators correctly hold no expectation that the public would know or even care about the wording of, say, FASB Rules 516 or 517 as a generally accepted accounting principle.
To balance a budget these same vice presidents for finance also estimate the income side of the ledger. Here the language follows not only GASB and FASB rules, but also the more public vernacular of “Tuition, Fees, Room, Board, Transportation, Books, and Other Expenses.” Vice presidents for enrollment management may use additional phrases like the “Cost of Attendance” or a “Comprehensive Fee” to explain the full price of going to college at an institution. They are using Price Language to explain the price of college.
“Ay, there’s the rub,” as the Bard reminds us. Price Language and Cost Language do not explain how much most families, and certainly not low-income families, will actually pay for college. Families must also understand Financial Aid Speak or be left with the impression that everyone pays $60,000 per year. Perhaps many families narrow their choices of where to apply because they are not multilingual, or maybe they speak Price Language and don’t understand Financial Aid Speak.
And why should they? Financial Aid Speak evolved from internal administrative activities at Medallion University -- procedures that now exceed half a century in age. “Expected Family Contribution,” for example, became the shorthand jargon of financial aid officers to explain how much a family would pay after the financial aid distribution to a student.
An “award,” (not to be confused some kind of “prize") has different components, i.e., the “package” is made up of “gift aid” and “self-help.” Ironically, these birthday sounding words reduce the family’s financial obligation, not only by the amount of money available to the family but also according to the admissions priorities of Medallion.
“Scholarships,” or “grants” – the so-called “gift aid” -- reduces the “net price” for a family, while a job or a loan – the so-called “self-help” -- requires labor and repayment. Who is “giving” this gift that requires payment of an unaffordable bill? And is the “help” really for the “self” or a down payment on the school’s operating budget? This language so familiar to the financial aid officers ignores the verbiage that an untrained family uses to consider college affordability.
Add the various proper nouns and one begins to think that Financial Aid Speak is a history exam. Pell, Stafford, Perkins, SEOG, Plus at the federal level, or Lindsay, Herter, Adams, Tsongas at the state level where I live in Massachusetts, are generous programs; but families often must find and recognize eligibility, and complete lengthy forms for these named programs, to receive the intended financial help.
“Net Price,” is the central concept for knowing how much a family pays for a college education. A consumer buying a car or a television or a computer would recognize the concept as the listed price minus any store discounts and rebates. The “Net Price” for a year of college is the price of attendance minus grants and scholarships from any and all sources.
Savings (past resources), wages (present resources), and loans (future resources) – both of student and parents -- describe the assets that a family will use to pay for all of these academic goods and services over time. This is the vocabulary of Payment Language; it is simple, direct, understandable and essential for general understanding of college prices. The public speaks Payment Language every day.
Recent research has shown that over half of the high-achieving students from low-income families never consider selective public and private colleges even though the price of attendance could actually be lower than the college they select.
Entitled “Boston’s Faces of Excellence,” the Boston Globe published the photographs and future plans for the valedictorian from each of the city’s 44 public high schools. The student destinations included selective private universities (Harvard, Boston University, Boston College, Northeastern), flagship state universities (the University of Massachusetts, the University of New Hampshire), state public colleges and universities (Westfield State and Bridgewater State), local colleges (Simmons, Mount Ida), community colleges (Bunker Hill), and undecided.
How many of these students made their choice of college knowing the financial options that were available from all sectors of higher education? Their preferred college could have depended on the best fit for each student, but one suspects that at least some of these students had a conversation that sounded like the one at the beginning of this essay. And for the valedictorians whose surnames are Lopez and Garcia, and who were born outside of the United States, one wonders how Financial Aid Speak translates into the parents’ native tongue.
Financial Aid Speak is a precise language; the verbiage describes what enrollment managers do when they decide about price discounts and eligibility for jobs and loans. Becoming articulate requires years of experience and training. When spoken well, it allows financial aid officers to compare pricing among a large number of college applicants from a variety of financial and academic backgrounds. It also produces an illusion of fairness by using standardized criteria applied equally and professionally to all applicants.
Financial Aid Speak, Cost Language, and Price Language, however, do not use words and phrases that provide adequate explanation to those that need pricing information the most – middle and high school students with low-income parents. Many education experiments indicate that simple, straightforward explanation about college pricing increases the college-going rate and available college options to low income families. Meaningful communication is a necessary condition for informed choice.
Payment Language uses words and concepts directed toward that objective. It can enlighten those who may have limited their college choice because they did not understand the available information about paying for college. Colleges must use words with universal meaning for financial transactions that explain the choices about what college to attend and how to pay the bill. We should adopt Payment Language, and follow these principles::
Payment Language adopts only words that are used in common financial transactions that are familiar to the public.
Payment Language produces comparable concepts about college pricing in all institutions from any sector of higher education, for all types of financial aid programs, and for all amounts of discounting and payment.
Payment Language uses “net price” – the amount of money that the family pays for one year of college -- calculated as the price of attendance minus grants and scholarships from all sources.
Payment Language separates financial obligation among the institution, student and parents.
Payment Language identifies the federal, state, institutional, and other programs and their associated eligibility requirements as a source of funding.
Payment Language identifies the expected timing for payment into past (savings), present (wages), and future (loan) financial obligations.
Payment Language includes the responsibilities for education loan repayment, including the interest rate, effect of compound interest, the total interest, monthly repayment, the possibilities for reduction and forgiveness as well as the incidence and consequences of default and bankruptcy.
Payment Language is as easily understood in Spanish as English and can be translated directly to other foreign languages.
These principles require testing. Conjecture about how people talk, the words they use, and what they understand is not enough to evaluate the benefits and the costs of a college education. Years of good intentions notwithstanding, our communications with the public about paying for college are confusing and often misunderstood outside of the academy.
C. Anthony Broh is the founder and principal of Broh Consulting Services and co-author of Paying for College. He has been constructing a universal “Language of Financial Aid” with financial aid officers for more than a decade.
Centre College on Tuesday announced a $250 million gift -- believed to be the largest ever to a liberal arts college -- that will support merit scholarships. Starting in the fall of 2014, 40 students a year will receive what the college is calling "full ride plus" scholarships, to cover tuition, room and board, all fees and additional money to support study abroad, research or internships. The funds will be available only to students majoring in the natural sciences, computational sciences and economics.
The U.S. Education Department last week announced significant changes in the array of providers it uses to service federal student loans, and the flurry of changes are likely to reinforce concerns among some student loan borrowers about how they and their loans are treated by the servicers (especially when their loans are split among multiple servicers).
The announcement from the department on Friday expanded on an earlier announcement about the agency's plan to phase out the involvement of ACS (which is owned by Xerox) from its student loan servicing team, and the addition of Nelnet. The statement, aimed at financial aid officers, also notes that the technology platform used by four nonprofit loan servicers is being discontinued, and that loans held by those servicers will be transferred to two other nonprofit service providers.
A ProPublica report last year documented the difficulties that some borrowers had encountered from having their loans randomly assigned to servicers (and in some cases multiple ones), including inconsistent or changing information about how much they owe, payment plans, etc.
The Consumer Financial Protection Bureau said in March that it would extend its oversight to student loan servicers.
An Education Department proposal to expand the scope and reach of its central database for student aid would violate federal law and distort the database's purposes, a group of higher education associations argued in a letter sent to department officials Monday.
The letter, sent by the American Council on Education on behalf of seven other groups, responds to a request for comment published in the Federal Register in late June, in which the Education Department's Federal Student Aid office proposed to make a set of changes to information collected by the National Student Loan Data System.
The associations' letter argues that some of the department's goals are appropriately tied to the database's original purpose, but it questions a plan to modify legal provisions related to gainful employment programs to collect information about students who do not receive federal financial aid, among other things. "[W]e do not understand how the inclusion of information about unaided students in NSLDS can be justified," they wrote.
The groups also challenged the department's plan to expand the student loan database to collect consumer protection and program evaluation data, and the department's authority to make such changes in a Federal Register notice rather than through legislation. The proposals, they write, "exceed the boundaries of the law in ways that the courts have prohibited and that distort the purposes of NSLDS."
The letter also cites numerous ways in which the department's proposal falls short of its obligations under the Federal Privacy Act.
The 2007 College Cost Reduction and Access Act (CCRAA) spawned two huge problems in federal financial aid: It caused fights over arbitrary interest rates and it established an ill-designed student loan repayment program.
On interest rates, the 2007 law gradually lowered rates on some student loans from 6.8% to 3.4% and then scheduled an increase back to 6.8%. Of course, once rates reached 3.4%, it was more than a little difficult to explain that this was an arbitrary number chosen in 2007, and therefore should exert no influence in determining rates going forward. Fortunately, Washington has finally come to its senses, and will avoid this problem in the future by tying interest rates on student loans to the government’s own cost of borrowing, thus fixing the first problem spawned by the CCRAA of 2007.
While we wait for the ink to dry on the interest rate compromise, policymakers should turn their attention to the even bigger problem with the CCRAA of 2007 – the income-based repayment (IBR) program. IBR, in typical Washington fashion, took a great idea — income-contingent lending (ICL) -- and “fixed” it until all that was good about it was no more.
What Income-Contingent Lending Can Offer
Under income-contingent lending, the amount borrowers pay each month is tied to their incomes, so borrowers repay less in months when their incomes fall (such as during an unemployment spell), and repay more quickly when their incomes rise. Arguments in favor of ICL are so strong that advocates have included the late Nobel laureates Milton Friedman on the right and James Tobin on the left.
ICL’s greatest strength is that it eliminates the possibility of default. Borrowers are never put in situations where they can’t afford to make their payments, since payments automatically decline when income declines. This is a huge stress reducer for students, and it can also be beneficial for lenders, since it reduces the possibility that they will get nothing back.
income-contingent lending also improves access and equality of opportunity. Current loan programs do not increase access as much as they should, because many borrowers fear being trapped in permanent financial purgatory by their student loan debts. By simplifying lending and eliminating the fear of default, ICL would be more attractive for those segments of the population that currently avoid student loans (and therefore college).
Another set of advantages stem from getting the government out of the student loan lending business. While an ICL with the government as the lender would be administratively cost-efficient (since loan repayments could be incorporated into the existing tax-withholding system), the benefits of moving to private lending are even greater.
It is true that past private student lending in this country certainly hasn’t inspired confidence, with subsidy-fueled corruption and high interest rates being the two most accurate descriptors. But these characteristics were driven not by anything inherent in private lending, but by poorly designed features of those lending programs. Past corruption was due to the fact that the federal government set interest rates and offered subsidies to lenders. And high current interest rates on private loans are due to the lack of collateral and the fact that individuals typically resort to private loans after maxing out their federal loan (meaning they already have a lot of debt, which makes lending to them risky). A properly designed ICL overcomes all of these problems, since there are no subsidies, the government doesn’t set interest rates, and the student’s future earnings function as collateral for their student loans.
The main advantage of private lending is that interest rates would no longer be one-size-fits-all. Currently, a stellar student in a field with many job opportunities (e.g., nursing) pays the same interest rate as a bottom-of-the-class student in a field with dismal job prospects (e.g., law) despite differences in the riskiness of lending to these two students.
With private lending that would no longer be the case, and the stellar nursing student would be able to obtain a lower interest rate than a slacker law student. Private lending would therefore provide students with more guidance on their choice of majors and provide incentives for students to do well in school. In addition, with private lending, the political pandering we just witnessed in setting interest rates would be eliminated, and public funding would be freed up for other uses (such as expanding Pell grants).
Potential Drawbacks of Poorly Designed ICLs
Some drawbacks can be exacerbated if an ICL is not properly designed. First is “adverse selection.” This is particularly problematic when borrowers are jointly responsible for their class (or cohort’s) total amount borrowed, as was the case in a Yale University experiment in the 1970s (more on that a bit later). With cohort-based accounts, those students expecting to have high incomes will avoid loans, while those students expecting low incomes will eagerly borrow, confident that others will repay their loans for them. This problem can be avoided by establishing individual, rather than cohort, accounts. While the amount due monthly for each student would still be contingent on income, the total amount repaid (except for interest) would not be. High earners simply would pay off their personal debt faster.
The second potential drawback is “moral hazard,” which could apply to students or colleges. Some students might try to deliberately lower their incomes to lower their monthly payments. While there isn’t much danger of students choosing to remain unemployed to avoid repaying their debts, there is the danger that some might seek out jobs with greater nonmonetary compensation such as travel or vacation time. This danger could be handled by designing individual accounts and eliminating loan forgiveness in all but the most extreme cases.
Moral hazard could also apply to colleges, if they see the students’ reduced fear of borrowing as a license to raise tuitions. Law schools are the poster children for this phenomenon, with loose lending standards for federal GradPLUS loans leading to skyrocketing law school tuitions and debt. This danger could be mitigated by including reasonable eligibility criteria and imposing strict annual and aggregate loan limits in the program’s design.
If ICL is so great, why has it failed (in America) so far?
While ICL has many advantages, and has worked in Australia, the United Kingdom, and New Zealand, two attempts in to implement an ICL program in United States have not worked. Fortunately, these experiments have taught us mistakes to avoid.
The first attempt at an ICL in America began at Yale in 1971. It suffered from two serious problems: it was limited to one college and it used a class account, rather than individual accounts. Running an ICL program on a single campus is difficult because colleges have difficulty verifying the income of graduates and collecting payments. The Yale program also used a cohort account in which every student had to keep paying until the entire class’s debt was repaid. High-earning graduates did not like the fact that they paid much more than they borrowed, while some of their classmates paid less. The Yale program stopped accepting new borrowers in 1978.
The second attempt to establish an ICL came in 2007 with the IBR program, which is still in effect. IBR originally limited payments to 15 percent of disposable income (defined as the income above 150 percent of the poverty line), with any remaining balance forgiven after 25 years of repayment (10 years if graduates worked in politically favored professions). The Health Care and Education Reconciliation Act of 2010 cut this to 10 percent of disposable income and 20 years until forgiveness.
Any one of these provisions could work by reducing the generosity of other provisions, but the combination of a large income exemption, low repayment percentage on remaining income, and easy and automatic loan forgiveness have transformed IBR from a ICL-based loan program into a delayed grant program.
This is made clear by the handy calculator Jason Delisle and Alex Holt at the New America Foundation created to accompany their excellent report "Safety Net or Windfall?" The average undergraduate college graduate who borrowed has $26,600 in debt. If a graduate’s salary grows by 4 percent a year, payments for any student with a starting salary under $30,300 (of which there are many) would not even cover the interest on his or her loans. After 20 years, the entire loan principal would be forgiven at taxpayer expense. In other words, many typical students will not repay their student loans under IBR. Instead, they will receive loan forgiveness worth tens of thousands of dollars. And if those borrowers have children, their loan payments go down even more. For example, if a borrower has a child five years after college, the borrower could have a starting salary of $35,000 and not repay a cent of principal over the life of the loan. In the understated words of Rep. Thomas Petri (R-WI), Income Based Repayment (IBR) “fails to live up to its potential.”
The bottom line is that IBR is no longer a loan program. It is a grant program, a delayed grant program. Politicians of both parties could not resist the temptation to promise current students and constituents huge giveaways years from now while leaving the job of figuring out how to pay for it to the policymakers who will inherit these unfunded promises in the future. To avoid this problem, the temptation to make repayment provisions more generous needs to be balanced by the requirement that promises are paid for at the time the promises are made. If politicians want to make the student loan program more generous, they should be the ones that have to sacrifice other priorities to do so, rather than leaving their promises unfunded and sticking future politicians and taxpayers with the bill.
One blatant example of the absence of balance is the continual debate over the length of time students make payments before their loans are forgiven. This debate is completely misguided – loan forgiveness is a solution to a problem (unaffordable payments) that would not exist under a well-designed income-contingent lending program, since ICL already ensures that payments are always affordable. The main reason for loan forgiveness in an ICL is to enable politicians to pander by making unfunded promises.
What Should be Done?
America’s past experiments with ICL programs have taught us valuable lessons about how NOT to design an ICL program. We learned that a single college cannot run an ICL program. We learned that individual accounts are better than communal accounts. We learned that the program should not include any loan forgiveness. And we learned that to avoid ever-increasing unfunded promises, the program needs to be set up so that more generous promises are paid for when they are made — by those who made them.
The advantages of income-contingent lending are so great that we should not delay in implementing this new and better student lending system, making sure to incorporate all the lessons we’ve learned the hard way.
Andrew Gillen is the research director at Education Sector.