Colleges set the tuition prices that students take out loans to pay. And the education they provide is supposed to help students get a good job and earn enough income to pay off their loans. Should colleges face penalties if their students can’t afford to pay back their debt?
Many people on different sides of the debates about student loans would answer yes. They say that colleges should have more “skin in the game” for unaffordable student debt among their former students, whether they be graduates or those who left without a degree.
Today, colleges do have some skin in the game when it comes to the federal student loans that their students take on, under a measure called the cohort default rate. A default is when a borrower fails to pay his loan for many months. Colleges whose former students default on their student loans at high rates (30 percent) can no longer participate in federal student aid programs, meaning their current students cannot take out federal student loans or receive Pell grants.
But many experts think this rule doesn’t do enough to penalize schools where students rack up unaffordable debt. Colleges can use certain tricks to keep students out of default during the three years of repayment that the government tracks, without actually helping those students repay. Very few colleges are ever punished.
Here are some ways that experts have proposed to make these rules more effective. All of these ideas are based on the concept that colleges need to face more penalties — or incentives — to ensure their students only take on affordable student debt. The idea is that penalties would force them to maintain the quality of their programs and to also charge reasonable prices or offer enough financial aid.
Sharing the Risk
Under a risk-sharing program, colleges would have to pay the government a fine for students who do not pay back their loans. This is different from the current default rule in several ways. The cohort default rate is an “all or nothing” test, meaning the difference between a college facing no punishment and facing a severe one could be a matter of a percentage point or less in the repayment rate of their former students. With risk-sharing, fines would go up or down based on the prevalence of unpaid loans, and the college can still let its students take out federal loans.
A risk-sharing penalty can also be fine-tuned so that colleges are penalized if students pay back very slowly, even if they don’t completely default. Slow repayment suggests that students’ debts are high relative to what they are earning after leaving school. This plan works particularly well if students’ loan payments are linked directly to their income, like in an Income-Driven Repayment plan or an Income-Share Agreement. That way the penalties track whether a student’s loans are appropriate for how much he or she goes on to earn after school.
A Test for Debt
Another type of student loan reform that’s been discussed, known as a debt and earnings test, would look directly at students’ earnings and debt levels. Under this approach, it is less important how many students are making on-time payments and how quickly. What matters is how much students borrowed compared to what they are earning in their jobs. If their debts are too high compared with their earnings, then the school could face fines or lose the right to participate in the federal loan program.
An Insurance Policy
Perhaps the most radical idea for holding colleges accountable for student debt involves insurance. This idea is similar to the proposals above in that colleges would face penalties if their students took on too much debt or repaid their loans slowly — or not at all. But the government wouldn’t be as involved. Instead, colleges would have to buy insurance from a private company for unpaid loans. The insurance company would then help cover any losses on unpaid loans that are owed to the government. The higher the unpaid loans, the more the college would have to pay to buy this insurance. The advantage of this plan is that a private company with expertise in pricing the cost of unpaid loans would set the fee colleges must pay, instead of the government.
Potential Unintended Consequences
Ultimately, there are tradeoffs and unintended consequences that come with tighter rules around unpaid student loans. And those issues have proved a major sticking point among lawmakers.
For example, there is a risk that colleges eager to avoid fines and penalties for unpaid loans may avoid enrolling students who might be seen as less likely to finish their degrees including low-income students. That could make our higher education system less fair. Another concern is that some majors, like social work, lead to jobs with lower pay but provide vital services to their communities. Colleges might respond to new accountability rules by shutting down these programs because their students’ earnings are low. Then there would be a shortage of social workers.
Ultimately, lawmakers must weigh these concerns against the potential benefits of stricter rules for unpaid student loans.
A resource from the Peter G. Peterson Foundation, created with collaboration from the Center for American Progress (CAP) and the American Enterprise Institute (AEI).
Take a deeper dive into holding colleges accountable for student debt using the resources below:
- Why the Cohort Default Rate Is Insufficient (Third Way)
- Designing Higher Education Risk-Sharing Proposals (Center for American Progress)
- Investing in Value, Sharing Risk (American Enterprise Institute)
- What to Know about the Gainful Employment Rule (The Institute for College Access & Success)
- Now Is the Time to Fix Cohort Default Rates (Center for American Progress)