What’s up, boys and girls? I’m a bit busy right now doing non-blogging stuff, so I’m going to hand the reigns over to my man Drew Cloud for a bit. Drew is the man to talk to when it comes to the student loan industry. His knowledge and expertise on the subject is extensive, and you can read all about the wonderful world of student loans over on his website, The Student Loan Report (which I gave him an A on).
Drew, the podium is yours. Everyone else, pay attention because this will be on the final.
Contrary to popular belief, the student loan industry has never been fully privatized.
Since 1965, individuals who did not have the money set aside to pay for attending a college or university had the opportunity to borrow from a guaranteed loan program known as the Federal Family Education (FFEL) loan. Although these education loans were made through third-party lenders in the private market, they were guaranteed by the federal government, creating the look of a privatized student loan landscape without it being that way in practice. Since that time, student loans have taken on a life of their own, affecting more than 40 million borrowers to the tune of $1.3 trillion among them.
Each new administration has promised to do something about the growing student loan crisis faced by American students, and while some progress has been made in recent years, some argue more can be done. On one side of the coin, politicians want a fully privatized student loan market, effectively taking the government out of the picture altogether. Others, however, want the federal government to play a greater, more efficient role in how individuals and their families are able to afford higher education costs.
Here are the pros and cons of each argument.
Student Loans and the Federal Government
Under the old system that created a strong bond between the federal government and private student loan lenders, several advantages were present. The interest rates charged on student loans were set by the government, not the private lenders themselves, keeping some semblance of affordability for borrowers. However, to make the process of loaning money to nearly any borrower who asked for it possible, private lenders needed some type of incentive. The federal government provided taxpayer subsidies as one incentive, and a guarantee to repay up to 97% of a loan’s principal and interest should the borrower default was another. Through this arrangement, private lenders were encouraged to lendto all borrowers, regardless of income, race, class, or creditworthiness.
In 2010, the FFEL program went the way of the VCR as a fully direct lending model was designed and implemented.
Under a direct lending model, the federal government has become the lender for student loan borrowers, removing the third-party private lenders – and their subsidies and other incentives.
According to the Congressional Budget Office, transitioning from the FFEL program to a direct government loan plan would save the government nearly $60 million from its start up to 2020.
Unfortunately, that savings is not passed on to student loan borrowers nor the schools which they choose to attend. The interest rates charged on direct student loans are still set by the government, and they are still well above auto loan, mortgage, and some personal loan rates. That makes it a challenge for borrowers entering repayment to pay off large amounts of student debt in a short period, or at all.
Adding to the disadvantage of a direct lending model is the continued presence of the federal government in the student loan business. While offering loans to all borrowers is the goal, having an almost guaranteed loan program means demand for college degrees continues to rise, which then pushes up the cost of tuition and other expenses. Student borrowers are left with little choice but to borrow for their educational goals, and they may be facing a life saddled with high-cost debt that deters them from moving ahead in their financial lives.
What Privatization Offers – and Takes Away
Some argue that removing the federal government from student loan lending is the right move, based on the notion that privatization brings greater competition to the market. With increased competition among private lenders, student borrowers would have the opportunity to shop around for the best student loan rates, either based on a guaranteed loan program set by lenders or a program closely tied to a borrower’s credit history and score. With more private lenders entering such a high-demand market, interest rates would naturally be brought down to entice borrowers to select one lender over another.
While privatization could work in a perfect world to lower the cost of borrowing for one’s education, most agree that would not take place without a fight.
Private lenders are in the business of making a profit that can ultimately be passed down to shareholders – not their customers. If profit is the aim, there is no promise that privatization of student loans would bring the cost of borrowing down at all, and in fact, it may increase the average interest rate applied to a student loan.
Additionally, private lenders offer little to no recourse for when a financial hardship strikes a borrower, unlike the options for forbearance or an altered repayment plan offered by the federal government. Because student loans cannot be discharged in bankruptcy except for very rare circumstances, private lenders have little incentive to make the student loan market more beneficial to borrowers. Many of them do refinance federal student loans to lower interest rates, an option only offered by the private market.
As the student loan crisis in American is continuing to get worse as students are forced to take on costly loans to fund their education, few can argue against the fact that a change needs to take place. While the direct lending model through the federal government has its merits, it also has drawbacks which include pushing the price of attending college upward. Similarly, privatization seems as though it could help bring the cost of borrowing down, but competition and a free market landscape do not always work out to the benefit of borrowers as much as it does company shareholders.
Time will tell how the student loan environment will take shape for future generations of students, and at what cost.
Readers–What do YOU think!? Should the student loan industry be privatized? Or is more government the answer? How do you think we should handle the current student loan crisis? Leave your thoughts in the comments below!