How Risk-Based Student Loans Could Conceptually Work

With the election of a Republican president as well as Republican majorities in Congress and among state governors much discussion has been raised about considering risk in student loans. While this is an unpopular concept among educational leaders, it is one that more conservative politicians and opinion leaders will give more study—and it does have potentially serious impacts on student borrowing.

Ideally, fiscally conservative politicians would want college students and their families to borrow as little as possible, especially if their degrees do not lead to specific career paths. They could lead student borrowers in that direction by limiting the principle, denying or eliminating the interest subsidy or offering disincentives (higher interest rates) to discourage them to take on more debt.  They could also set income limits, which was done in the early 1980s when I was in college, or change credit terms based on a family’s financial situation.

Risk-based student loan programs could also consider the default rate of the student’s chosen college. It is conceivable that a fiscally conservative Congress combined with a fiscally conservative President could allow borrowers who attend colleges with high default rates to borrow less, or ask the college to assume some of the risk. That could seriously compromise the quality of services, the financial health and the future student markets for such schools.

My audience and my concerns, however, are with parents and students. While a family’s financial situation would remain an important consideration in student loan lending decisions, there are student-centered aspects as well, including.

• The student’s ability to earn academic awards that would reduce the costs of their education. Lenders would consider a college’s total cost of attendance: tuition and fees, room and board, books and a living/transportation allowance, then consider what the student has done through their academic performance to reduce those costs at the start of the school year. No lender should allow a student to borrow more than s/he needs to meet their total costs of attendance. However, it is conceivable that a lender might offer a lower interest rate to a very good to excellent student vs. a poor to middling one.

• The student’s ability to work while pursing their degree. A lender might be willing to extend more favorable terms to students who are working to help pay for their education, whether it be to cover expenses or build their resumes towards a goal after graduation. A fiscally conservative lender could conceivably view a student who earns, saves or has a clear direction to be less of a risk than a student who does not.

• The student’s year in college. For a risk-based lending program to be fair, it would probably offer the same terms to first and second-year students, regardless of their major. Intended major cannot be a lending consideration for most first-year students. Most have not taken a full semester of college-level classes nor are they in the position to commit to a major. However, a junior or senior would be a lesser risk because s/he has made a stronger commitment towards completing a degree.

• The student’s chosen major. This is the area where politicians have sounded off the most, the idea that a college student who is enrolled in a high-demand, pre-professional major is less of a risk than one who is not. A lender would rely on labor market and salary data to determine risk and credit terms. In theory, a student who is enrolled in a major that leads to immediate employment should be able to begin repaying their loans faster than another student who is not.

Can any of these considerations impact a college list or a college choice for future students?

Of course, they can.

More students would gravitate towards less expensive educational options, especially if they plan to go on for further education or want to opt for a degree program that has few or no defined career paths. Others might be swayed towards schools based on their reputation as target schools that have better connections to internships and jobs with larger employers. Or they might be steered towards schools where they hear that it is “easier” to complete a degree in a major that is more likely to lead to full-time employment after college.

Fiscal conservatives would certainly hope that more students would become motivated to work, save and build upon a post-college direction as well as find full-time jobs after graduation. That is possible but not likely unless high schools  and colleges can become more invested in helping students to make these choices. If a risk-based policy is combined with further cuts in state and local spending for counseling and career development at public schools and colleges, higher levels of student success are less likely to happen.

A greater concern is that students who find an “immediately employable” major to be too difficult will simply give up on the opportunity to earn a college degree. Those students will have borrowed and spent time in college for nothing. They and their lender will have the most at risk.

For more insights about student loans and financial aid, contact me at stuart@educatedquest.com or call me at 609-406-0062.

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