Big Ben's Blog

Lenders Are Avoiding Giving Loans to Low-Income Students

Ben Miller — Mon, 02 Jun 2008 23:15:49 EDT

There’s an interesting story in the New York Times today about how some student loan companies have stopped offering loans to some students at community colleges and “other less competitive institutions.”

At face value, the move appears to be an ongoing reaction to the effects of the credit crunch on the student loan market, a topic both Kay and Pedro have written about. Essentially, a worldwide lack of people and institutions willing to lend money raised the cost of borrowing for loan companies to the point where the guaranteed return they received from the government was insufficient for the loans to be profitable. As a result, some lenders have stopped offering federally-guaranteed student loans, in which the government pays up to 97 percent of the value of a defaulted loan and gives the lenders a quarterly subsidy known as a special allowance payment.

Given that loans already appear to be turning smaller profits, the decision to stop lending to schools where students are more likely to default on their debt makes sense from a pure capitalistic standpoint.

But the federal student loan market is far from a free market enterprise. As mentioned above, lenders are given governmental subsidies to make the loan and stand to lose no more than 3 percent of the loan. In addition, under a plan unveiled by the Department of Education on May 21, lenders will now also be able to receive a low-interest government loan to help stay in the market.

So what are lenders doing with this governmentally-subsidized money? Not putting it toward the neediest students who are most likely to require financial assistance in going to college, and also the most likely to drop out if faced with too many hurdles.

The fact that companies can take government money and then essentially redline low-income students suggests that perhaps an incentive should be introduced that lenders hoping to take advantage of these funds cannot dramatically adjust the schools they are willing to serve.

While what the loan companies are doing may appear immoral, it is not illegal. It does, however, both expose a major flaw in the federally guaranteed student loan market and raise questions about the actions and motivations of the schools that are getting passed over.

First, let’s consider the school’s motivation. If there are concerns about finding lenders to offer loans, why don’t these institutions take the obvious step of at least applying to join the Direct Loan program? Direct Loans are dispersed by the Department of Education using U.S. Treasury funds. Because the money comes straight from the government, any school in the program will always be able to get loans so long as it continues to meet eligibility requirements. The article doesn’t address whether these schools are considering switching, but it certainly seems that if colleges really have their charges’ best interest in mind they would at least entertain the idea.

Finally, the decision by loan companies to be more selective institutionally exposes an inherent flaw in the federally guaranteed student loan market: the loans are an entitlement for students, but no lender is required to make them. Congress sets the subsidy rate for lenders and hopes it’s sufficient to get companies to make loans. But as the Times article shows, what could be enough for loans at one type of school may not work elsewhere. Creating a system where companies bid with one another for the lowest subsidy at which they will make loans to all students in a given state or region would at least ensure that certain schools couldn’t get bypassed.

Income, Financial Aid and College Admissions

Ben Miller — Tue, 01 Apr 2008 23:01:48 EDT

It’s been less than 48 hours since the most elite colleges and universities in the country made their admissions decisions available to prospective applicants, and already stories are popping up about record low admission rates. As usual, the figures are minuscule: Harvard took just 7.1 percent of its applicants, Columbia 8.7 percent. By contrast, Dartmouth College, with a 13 percent acceptance rate, may as well have just thrown its doors wide open.

It’s not surprising to see record-low acceptance rates given the surge of applications over the past year, but looking at overall figures fails to answer important questions such as how many of those seven accepted students out of every 100 applicants comes from a low-income family? (For that matter, how many of those rejected 93 do as well?)

These are important questions, especially given the highly trumpeted recent decisions by a number of colleges to eliminate all loans for students that meet certain income requirements. Some of these policies are sensible, such as Washington University in St. Louis’s elimination of loans for families making less than $60,000. Others, such as Harvard’s dramatically slashing costs for families making up to $180,000, are deeply flawed.

Setting aside the issue of whether these policies will lead to an increase in the socioeconomic diversity of America’s elite campuses, it is worth considering some potentially negative ramifications that could arise if other, less wealthy schools start down the no-loans path.

The problem, as laid out in an excellent piece in Inside Higher Ed concerns what would happen if schools that are need aware (meaning they factor the applicant’s income into at least some admissions decisions) start eliminating loans. Under this hypothetical situation, a school might offer spots to fewer low-income applicants because each one is more costly (a $40,000-plus scholarship versus maybe half that amount and loans). This would result in an outcome where moves designed to cut costs for poorer applicants led to fewer low-income students accepted.

While the Inside Higher Ed example is crucial for considering how no-loans policies work within the larger sphere of postsecondary education, it is important to offer a few caveats and considerations. First, it is possible for a school to have generous aid, not be need-blind and still have good socioeconomic diversity. The perfect example of this is Smith College, an all women’s school in Northampton, Mass. Through both its Ada Comstock Scholars Program and a general institutional commitment, the school has succeeded in putting together a student body that has the best diversity among the richest colleges and universities — 33 percent of Smith’s students come from families with incomes below $60,000, 19 percentage points above Harvard’s mark.

While Smith has not eliminated loans for its students, its experience does show that institutional generosity need not hamper socioeconomic diversity — provided a school is willing to make a strong and concerted effort to admitting low-income students.

It’s also important to consider the combination of no loans and being need aware in the context of affirmative action. If more and more court cases and state laws continue to side against admissions decisions based on race, then it is likely that income status will become the next criteria for achieving diversity. In this case, colleges would consider income anyway and the issue would become if they guaranteed to meet 100 percent of demonstrated need.

Two Recommendations

From a mere equity standpoint it is important that all colleges, and especially those considering going no loans, commit to a need blind admissions policy. As the numbers at elite schools demonstrate, it is hard enough to get into college these days, the least universities can do is guarantee that the reason the student did not get in was completely unrelated to their ability to pay.

Second, it is time for colleges to begin doing a better job reporting the socioeconomic diversity of their campuses. Schools are more than happy to trumpet statistics on racial diversity, but data on family income is practically non-existent. The Web site economicdiversity.org, one of the best sites for institutional data, is only able to extrapolate about the low-income makeup of colleges using the income of financial aid applicants and recipients of Pell Grants, which generally go to students from families making under $40,000 a year. Therefore, all schools should be required to report both the average income of their admitted students and the breakdown within income quintiles.

These two changes won’t fix all the problems of access and equity, but they will ensure that when those gaudy admission figures come out in the future we will know for sure that all students, regardless of income, got a fair shot, and we shall see just whether the wealthiest schools are elite, or just for elites.

Congress, the Economy, and Student Loans

Ben Miller — Tue, 18 Mar 2008 22:58:15 EDT

There has been a lot of speculation recently about how the slowing economy could harm access to student loans. A few lenders have announced that they will stop offering, or originating, new loans — moves that have prompted hearings by both the House and the Senate. Given this uncertainty (and some overly alarmist stories by respected news outlets) its worth saying a few words about what really is, and is not, at risk in the student loan “crisis.”

What’s at Stake?

What is not at risk is federal student loans. The decision by the Pennsylvania Higher Education Assistance Authority, a large lender, to stop offering federal loans received numerous press hits, but it obscures the fact that there are over 2,000 other private lenders still offering loans. Even if large numbers of lenders went under, students would still have two viable options for loans: loans of last resort and the direct loan program

The lender of last resort program is a rarely invoked provisionthat guarantees students will receive loans through a guaranty agency, a middle-man that reinsurances loans for the government, if their loan application has been denied twice. The Direct loan program, meanwhile, involves the U.S. Treasury providing loan funds through the Department of Education. This is in contrast to the Federal Family Education Loan Program (FFELP), in which students get funding through private companies such as Sallie Mae. (Click here for more on the difference between the two programs). Regardless of how students get the loan, their borrower benefits remain exactly the same.

So what is at risk? The answer so far appears to be students trying to take out private loans at some for-profit schools. A lot of these are subprime loans given to students at questionable institutions that put a greater emphasis on enrollment figures than teaching quality. This represents an estimated 2 to 3 percent of all borrowers — many of whom are likely to fall in the 50 percent of borrowers who turn to private loans before exhausting the up to $46,000 that students can annually take out in federal loans.

A number of prominent individuals, such as Secretary of Education Margaret Spellings, Sen. Edward Kennedy (D-MA) and Rep. George Miller (D-CA), have echoed this argument in letters to college presidents.

Congressional Action

Then there are the Congressional hearings. Kennedy held his own in Boston on Monday, but it wasn’t available online or on TV. Miller, the chairman of the House Education Committee, also held his own hearing last Friday, but this revealed less about the state of student loans and more about how partisan any issue can become. Despite his previous calm, Miller used the hearing as a chance to badger Spellings and other members of the department about their preparedness for enacting lender of last resort provisions or expanding the direct loan program. This came across more as a chance to skewer a political opponent, rather than genuine concern.

The Republicans on the House Education Committee weren’t much better. Howard “Buck McKeon” (R-CA) mostly ignored the issue of availability after his initial statement, turning the focus instead to a fight over direct vs. FFELP loans (Republicans oppose direct loans, seeing the program as an unnecessary expansion of government).

The Big Picture

During all the bluster on student loan availability, there has been one major issue noticeably absent: the cost of college. Students would never need such large loans had the cost of college not increased at such an astronomical rates over the past few decades. It doesn’t help that many states (and the government) have announced plans to slash some higher education funding for the coming year — decisions that will undoubtedly lead to larger tuition bills. Given that federal loans continue to be widely available, perhaps Congress would be better served to stop obsessing over a “crisis” and take action that would reduce the need for loans in the first place.