A Solution to Student Loans

April 29, 2014

There is a better way to handle student loans, say Miguel Palacios assistant professor of finance at Vanderbilt University's Owen Graduate School of Management, and Andrew Kelly, director of the Center on Higher Education Reform at the American Enterprise Institute.

While borrowing for a house requires a calculation of the borrower's ability to pay, getting a student loan requires nothing of the sort. Because getting a federal loan is so easy, colleges have little incentive to keep tuition low and students are not deterred from borrowing large sums of money.

  • At the height of the housing crisis, the delinquency rate on mortgages was 10 percent.
  • In 2013, the delinquency rate on student loans was even higher, at 12 percent.

Palacios and Kelly suggest the use of income-share agreements (ISAs).

  • An ISA is not a loan, so students are not left with an outstanding balance.
  • Instead, investors finance a student's education in return for a percentage of his income over a certain period of years.
  • Students earning more than expected pay more -- and those earning less than expected pay less, even nothing, if their degree does not translate into earnings.

This type of program would protect students from the risk associated with a traditional student loan. An ISA system would also point students toward the programs most likely to result in a well-paying job, because investors will want to offer reasonable ISA terms for students enrolling in cost-effective programs. Ultimately, ISAs could bring down tuition inflation and make college more affordable.

In 2008, the Higher Education Act was reauthorized, banning a federal database linking postsecondary education and wage information. That ban, argue Palacios and Kelly, must be repealed in order for a vibrant ISA market to emerge.

Source: Miguel Palacios and Andrew P. Kelly, "A Better Way to Finance That College Degree," Wall Street Journal, April 13, 2014.

 

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