HESA

Higher Education Strategy Associates

Category Archives: student loans

October 07

Do the Poor Really Pay More?

There’s a trope out there that goes something like this: “Loans are unfair because interest on the loans means that needy students pay more in total to go to school than students who don’t need a loan“.  If it were true, this would indeed be problematic.  But the thing is, for the most part, it’s not.

Let’s follow two hypothetical students: Claudia and Eveline.  Claudia can manage to pay $25,000 for her four years of tuition, upfront; Eveline cannot, and she borrows $25K from Canada Student Loans and her provincial student aid program over four years.  Assume that inflation is a constant 2%, and that interest during the repayment period is 6.25% (over the last few years, real interest rates have floated between 400 and 450 basis points above inflation).

Student loans carry zero interest during the in-study period.  This means students actually make money while they’re borrowing because inflation eats away at the value of the loan before they’re required to pay it back.  In Eveline’s case, she effectively makes $1,125 between the September she starts and graduation day.

Then, of course, things start to work in the other direction.  Assuming Eveline takes eight years to pay off her student loan, she ends up making $4,321 in interest payments (figure is net of inflation).  Take away the $1,125 that Eveline “made” during the in-study period and the net interest cost comes to $3,196.

If that were the end of the story, the people who claim loans are “unfair” would be right; we would be discriminating against the poor.  But that’s not the end of the story because people who get loans usually also get grants.

If you’re an independent student making less than $38K per year and you apply for aid, you are nailed-on for an extra $2,000 per year – that’s $8,000 over the course of a degree.  Ditto if you’re a dependent student and your parents make less than $38K.  If you’re a dependent student and your parents make less than (roughly) $76K, you’re nailed-on for another $800/month – or exactly $3,200 over four years, which wipes out the interest cost of the loan.  Plus, of course, you get 15% of all interest paid as a tax credit – which means you actually come out ahead by a few hundred dollars.

Are there borrowers who don’t come out ahead?  Yes.  Those who borrowed but had family income high enough that they didn’t qualify for the middle-income grant likely wouldn’t receive a grant to offset the loan interest amount.  Borrowers who take more than eight years might end up with higher interest charges not covered by their grants (and possible remission).  There are enough variables here that it’s hard to say how many people this might include.  But remember – the base population that doesn’t get sufficient offsetting grants consists of dependent students with family incomes over $80K, that’s *maybe* 20% of all borrowers (and not the poorest 20% by any means).  Or to put it another way: probably something like 80% of borrowers are receiving more in subsidies than they pay in real interest over the life of their loan.

That’s a good thing – an outcome of our generous, if opaque, student aid system.  We should acknowledge it, celebrate it, and most of all get the usual suspects who adore this talking point to shut up about it.

March 18

How ICRs can Become Graduate Taxes: The Case of England

As noted yesterday, graduate taxes and income-contingent loans have many similar features.  They both defer payments until after graduation, and they are usually payable as a percentage of marginal income above a given threshold.  In England right now, the payment scheme on ICR loans is that students pay 9% of whatever income they earn over £21,000 (roughly C$38,000).  The difference between the two is that with a loan you have a set amount to pay, and when it’s paid you’re finished.  With a graduate tax there is no principal, so you just keeping paying that fraction of your income for as long as the tax lasts.

That sounds like a simple and clear delineation, right?  Well, here’s a twist: what if the loan were so big that you had no practical chance of ever paying it off at the set repayment rate?  What would the difference between an ICR and a grad tax be then?  The answer is: practically nothing – and that’s exactly where England finds itself right now.

Let’s step back a bit: in 2010, the UK government decided to let institutions charge tuition up to £9000.  They also decided to allow students to borrow this amount for tuition (plus more, again, for living expenses) under the repayment scheme described above.  When they did this, they were under the misapprehension that universities might actually try to compete for students on price, and hence assumed an average tuition of about £7000.  Rather predictably, average tuition shot straight to £8500.  As a result, it’s quite common for students to be borrowing £12-13,000 per year, or £36-39,000 for a degree (that’s C$66-72,000 – yes, really).

Crazy, right?  Cue all the “intolerable debt burden” stuff.  But wait: these loans aren’t like the ones we’re used to.  Repayment is based on your income rather than size of debt – no graduate is ever required to pay more than 9% of their income over £21,000 in any given year, so the burden in any given year is pretty limited.  And – here’s the kicker – the loan gets forgiven after 30 years.  So, if you don’t finish paying, your obligation disappears without you having any debt overhang. Exactly like a Graduate Tax.

How many won’t pay it off?  Well, these things are difficult to predict, but even over 30 years, paying 9% of your income over $38,000 isn’t likely to completely pay off very many of these loans.  The government’s own financial forecasts are that 35-40% of the total net present value of the loans will have to be forgiven (others put it 8-10% higher).  At a rough estimate, that probably means 70 to 80% of all borrowers will see some loan forgiveness.

At this point you start to wonder if debt numbers really matter in this system.  Forget ICR: for most people, the current system is simply one in which government transfers billions of pounds in 2014 to institutions using student loans as a kind of voucher system, then turns a portion of those loans into student grants in 2044 via loan forgiveness.  In the meantime, graduates pay a 9% surtax on income over £21,000.

Altogether, a very wacky system.  Not a model for anyone, really.

March 17

Oregon’s “Pay It Forward” Scheme and the ICR vs. Graduate Tax Problem

You may have heard some rumblings from south of the border over the past few months with respect to a program called Pay It Forward (PIF).  The brainchild of a student group called Students for Educational Debt Reform, this idea was picked up by the Oregon assembly last summer; within a few months, over a dozen state governments were examining similar draft legislation.

The basics of the program are these: instead of paying tuition, students agree to pay a percentage of their future income (the percentages vary by state – in Oregon it’s 0.75% per year of study) for 20 years after graduation.  Some people mistook this for a version of income-contingent loans because it emphasized paying for school after-the-fact rather than up-front, and also because repayments were to be made as a function of income.  But there’s one key difference.  Loans have a limited liability: once you pay off the principal and interest, you’re done.  With PIF, there is no principal – once you start paying into a hypothecated fund, destined for the state’s higher education institutions, you keep on paying for 20 years no matter what.  This is formally known as a “graduate tax”.

Graduate taxes tend to be more progressive than income-contingent loans.  If you’re at the bottom of the income scale, you probably come out better off – you simply never pay anything.  If you’re at the top of the income scale, you’re likely going to pay a lot more because a portion of your income will go into public coffers long after you’d likely have paid off a loan.  Interestingly, the famous Yale Tuition Postponement Option of the early 1970s (designed by Nobellist James Tobin, and used by Bill Clinton when he attended law school there) went off the rails for precisely this reason – the richer students got tired of paying for the poorer ones, and started making a fuss.

One downside to a graduate tax is that it’s harder to collect than a loan.  In the US, for instance, it’s hard to imagine enforcing something like PIF, unless it was instituted nationally (if someone moved from Portland to Chicago, would Illinois be responsible for collecting the PIF contribution?).  A graduate tax was in fact examined relatively thoroughly not once but twice in England (the 1997 Dearing Report and the 2005 fee reform), and was rejected precisely because of concerns about grads evading repayment through emigration.

Another downside is: where exactly does the money come from while you’re waiting for graduates to start earning money?  If tuition is covering 40% of institutional expenditure, someone has to make that income good over the 20 or so years before the grad tax makes up the difference.  It’s not clear who that might be; if the state had money to do this, it probably wouldn’t be faffing around with ideas like PIF.  You could securitize the revenue stream, of course, but that also might get tricky.  Income-contingent loans lack graduate taxes’ most potentially progressive features, but they do have the advantage of: a) being collectable, and b) producing income for institutions in the short term.

There is of course one country that is trying very hard to merge the ideas of ICR and graduate taxes, with some really odd results.  More on the English experiment tomorrow.

February 27

New Student Debt Numbers

So, the more stat-minded among you may have noted the release, this past Tuesday, of Statistics Canada’s 2012 Survey of Financial Security (SFS).  Though the main talking points were largely about mortgage debt, it also contained some interesting statistics on student debt.

Now, remember that these are figures on outstanding student debt.  Some of it will be in repayment (i.e. held by graduates now in the labour force), and some of it will not (i.e. held by current students).  The way to think of these debt figures is as a collective portrait of people who borrowed in the decade or so prior to the snapshot, and who had not yet fully repaid their debt (because those who had successfully completed repayment would be out of the sample).  So the 2012 figure for student debt is actually a collective picture of the outstanding debt of everyone who borrowed in the period 2002-2012, and who had not yet repaid, the 2005 figure covers the period 1995-2005 or so, etc., etc.

Anyways, the headline that the usual suspects would like you to focus on is the one about aggregate debt outstanding: $28 billion, up by $5.5 billion (23%) in real dollars since the last time the study was conducted, in 2005.  Why is that a big deal?  Because!  $28 Billion!  Big Number!  But a slightly more intelligent look at the data shows a different story.

Figure 1 shows that the average outstanding student loan was about $15,000.  That’s up about 6% from 2005, and 13% from 1999 (again, all figures are inflation-adjusted).  Why is this figure so much smaller than the one for total debt?  Simple: more people have outstanding student debt than in 2005, so it’s divided among a larger population.  That might be because people are taking longer to repay their loans – more likely, though, it’s a reflection of the fact that student numbers as a whole rose substantially over the 00s.

Figure 1 – Average Student Debt Among Holders of Outstanding Student Loans, in $2012

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Intriguingly, the data for median student debt (that is, the mid-point value, rather than the mean) tells a slightly different story, in that it fell 2% between 2005 and 2012 (though it has still risen a bit since 1999).

Figure 2 – Median Student Debt Among Holders of Outstanding Student Loans, in $2012

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How should we interpret this?  This isn’t the easiest data to unpack.  It probably means, as I pointed out back here, that student debt hasn’t been increasing.  But it also might mean that debt repayment rates have been increasing along with indebtedness, or (less likely) that a greater fraction of student loans are held by individuals who graduated from shorter programs.

Whatever the truth, what we do know for sure is that young people aren’t drowning in student loan debt.  Among family units headed by people under-35, only a quarter hold a student loan, and the loan debt constitutes just 5.3% of their total debt, down from 6.7% in 2005.  Whatever the effects of student borrowing is, it would appear that deterring graduates from taking on ever-larger mortgages isn’t one of them.

January 28

Why Student Debt Burden is Falling Like a Stone

Everyone talks about “rising student debt burdens” as if they are real.  But they’re not.  In fact, the burden of carrying a student loan has fallen significantly over the past decade.

Student loan burden is best measured by looking at the percentage of monthly after-tax income that it takes to service a loan each month.  This figure will therefore be affected by four different factors, namely: the size of student loan debt, interest rates, post-graduation income, and taxes.  Here’s what’s happened to each of those over the past 25 years:

1)      Student debt rose very quickly in the 1990s, more than doubling between 1992 and 2000.  This was because the federal government raised lending limits, and provinces by-and-large cut their grants programs.  Starting in the early 2000s, however (for reasons I’ll get into tomorrow), growth in student borrowing stabilized.  As a result, student debt has been roughly constant in real terms for over a decade now, as I showed back here, and may even have decreased a bit.

2)      Interest rates.  Nobody remembers this, but during the early 1990s, when we had the triple-whammy of the peso crisis, the sovereignty crisis, and an inflation-obsessed John Crow as Governor of the Bank of Canada, our interest rates were regularly 400 basis points higher than the Americans’.  They’ve come way, way, way down.  In 1991, prime briefly hit 14%, and throughout the 90s it averaged about 7.5%.  Today it’s 3%.

3)      Post-Graduation Income has remained remarkably constant over time.  Between 1988 and 2005, it didn’t change a bit in real terms.  Growth has been below inflation in the last few years because of the long recession, but it is still growing in nominal terms (we know this thanks to the many provincial graduates surveys, which have replaced the NGS as our key source of data on this subject).

4)      Taxes.  They’re down a fair bit.  Someone with average graduate income, 2 years out of school, paid out 28% of their income in taxes in the early 90s; now they pay 22%. (Thanks to Kevin Milligan and his great CTaCS program for the help in calculating this.)

In other words, things were pretty bad in the 1990s.  But since then, most of the relevant forces that underpin student loan burden have been heading in the right direction: debt is stable, or even down a bit, interest rates are down, taxes are down, and until quite recently income was more or less stable – and even now isn’t down very much.  Put it all together and what you see is that the after-tax repayment burden for someone with average student wages, repaying an average-sized student loan, has fallen sharply in the last decade:

Figure 1: Percentage of Average After-tax Earnings of Graduates, 2 Years Out, Required to Service an Average Student Loan

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That’s right: the burden of carrying an average loan, with an average salary, has fallen by over a third in the past decade.  It’s actually back down to where it was in 1992, before the rapid rise in tuition and debt of the 1990s.

I no longer expect facts to get in the way of people trying to manufacture a good crisis, but if anyone does happen to care about the data, there you go.

January 20

Canada’s Income-Contingent Loan System

I see that yet another group has called for Canada to have an income-contingent Loan Program to help students fund their higher education studies.  Great idea.  In fact, it’s so great that the country adopted an income-contingent system five years ago. It’s just that nobody noticed.

Many people think that income-contingency requires that loan repayments be a fixed percentage of individual income, or that loan recovery be handled through the tax system.  While it’s true that some of the world’s more prominent examples of income-contingency (e.g. Australia, UK) have those features, those aren’t necessary characteristics of an income-contingent system.  All “income-contingent” means is that repayments to some degree reflect a borrower’s ability to repay.

Canada has had some element of income-contingency ever since the “Interest Relief” program was introduced in 1984.  Something of a misnomer, Interest Relief allowed unemployed borrowers in re-payment to suspend principal repayments for up to 18 months, during which time government would pay the interest on the loan.  The program was expanded in 1994 to include borrowers who were employed but had high debt service ratios.  In the 1998 Budget, the time limit went up to 30 (or in some cases 54) months.  That budget also announced a system whereby borrowers who didn’t quite meet the test for full interest-relief could get a partial subsidy – unfortunately, this system was never implemented, because the government, and the banks who administered the program at the time, couldn’t figure out how to make it work properly.  But the idea came back again in the 2008 Budget, with the introduction of RAP, which was basically the 1998 plan with some knobs added on.

So, like Australia and the UK, we have a system where borrowers with low-income pay nothing, and a system which phases in loan repayments gradually as borrowers begin to earn more money.  The only major difference between Canada and Australia/UK is that we say if you’re above a certain income level, you should be paying off a loan quickly under a normal system of amortization, whereas they say the hell with it, and just take a proportion of your income because it’s simpler to manage that way.

Why don’t we call it income-contingency?  Basically, it’s because no one wants to embarrass the Canadian Federation of Students (CFS).  For years, they insisted income-contingency was the work of Satan because in making loans easier to pay it paved the way for higher tuition fees (yes, really).  Yet, as the details of RAP were developed, they decided they quite liked it.  Since it’s rare CFS actually backs a government program, it was generally agreed that pointing out to them that that RAP was in fact income-contingency (which they still in theory strenuously oppose) would create unnecessary problems.

So there you go.  We have a reasonable student loan repayment system, which the main players like but no one else understands.  It’d be nice if we could find a way to communicate this to the country so we could stop with the inane demands for income-contingency, but c’est la vie.

December 05

Income-Contingent Loan Problems

Everyone who’s ever given thought to the matter thinks that income-contingent loans are superior to mortgage-style loans.  At any given level of debt, it’s always preferable for low-income borrowers in repayment to have the option to suspend payments, and make them up at a later time.  Pretty much all the objections to income-contingency – especially here in Canada – are about matters extraneous to the actual method of loan repayment (e.g. fees would rise, interest is too high, etc.).

The reason that income-contingent loans work for borrowers is that they operate on the principle of, “can’t pay today?  No worries, catch you tomorrow”.  On average, that’s true: where students have low-income early in their repayment period, their incomes later on usually rise sufficiently to pay off the debt without difficulty.  The problem is that while this is true on average, it’s not true for everyone.  And that means loan losses. While losses are part and parcel of any publicly subsidized loan system, at least with “regular loans” you can see those losses more or less as they occur, and can make provisions for them on that basis.

But the Australian Higher Education Contribution Scheme (HECS), and its English counterpart, basically assumed away the problem of losses (no worries, catch you tomorrow).  That led them to do a lot of really dumb things with respect to loan repayment thresholds.  In both countries, when tuition fee increases were in the offing, governments tried to calm students by offering them breaks on repayment terms: in Australia, “no repayment” now occurs below A$51K in annual income; in England, the threshold rose from £10K in 1998 to £15K in 2005, to £21K in 2012.  And each time it rises, a few more borrowers became less likely to repay the full value of their loan.

The problem is that, eventually, tomorrow arrives.  In Australia, of the $25 billion that has been issued in HECS debt, $6 billion has been written-off – that’s up from just $2 billion in 2006 (and that’s in addition to billions in loan interest subsidies).  In England, they’re so worried about the long-term costs of non-repayment that they’ve effectively halted any growth in enrolments, so that the loan portfolio doesn’t get any bigger.

None of this is really the “fault” of income-contingency, per se.  It’s more the fault of deliberately setting repayment thresholds at levels where poorer graduates won’t repay; lower the threshold and the problem goes away.  It’s not even really clear that it’s a problem – ensuring that the poorest graduates don’t repay their loans is arguably a pretty sensible subsidy.

But there’s still a public policy failure here.  Governments lost control of part of the education budget because the “catch you tomorrow” attitude meant there was no default mechanism to tell them when things were going wrong.  And that actually is a problem with income-contingency – and future loan program designers need to consider it carefully.

April 26

A Thought for Gabriel Betancourt

In early 1918, a fellow by the name of Gabriel Betancourt was born in Medellin, Colombia.  If the name sounds faintly familiar, it’s probably because of his daughter, Ingrid, the Colombia politician who was famously held captive by FARC guerrillas for six years.  But in education, Gabriel is the one that matters.  He’s the one who invented the idea of student loans.

To be fair, student loans weren’t entirely unheard of prior to WWII, but they were rare, and were offered by institutions themselves – Harvard’s loan program, for instance, dates back to 1840.  Betancourt’s innovation was to have the state, rather than individual institutions, offer the loan.  Thanks to his efforts, in 1950 the Colombian government set up ICETEX to help Colombian students finance their education, with Betancourt at the helm (he became Minister of Education a few years later).

Student loans took awhile to catch on.  It was another eight years before the US government began issuing loans under the National Defence Education Act; but it wasn’t until the 1965 Higher Education Act that they became available to students in all disciplines.  Japan, with its high university fees, was an early adopter, but so too were Denmark, Norway, and Sweden, who provided loans to help students with living expenses.  Canada’s loans program started in 1964.   The 1980s and 90s saw a large surge of new loan programs, many of which were inspired by Australia’s income-contingent model.  Not all of these were well-designed, and some essentially became grant programs because of non-repayment (rule one: never implement a student loan program in a country without a credit bureau).  But they continued to spread throughout Latin America, Africa, and East Asia.

Student loans often get a bad rap.  But most of the criticism is misplaced, for two reasons.  The first is misattribution of problems: people with high debts and low salaries aren’t in trouble because of their loans, they’re in trouble because their educational investment didn’t turn out so well.  (Loss-making money managers lose money because they’re crap at stock-picking, not because they borrowed money to buy shares; the same logic applies).  But more importantly, critics of loans use bad counterfactuals.  The alternative to a loan isn’t usually a grant; it’s nothing at all.  For millions of students around the world, loans are the only way to make education affordable and accessible – and on the whole they are remarkably successful and efficient in doing so.

Betancourt died in 2002, but tomorrow would have been his 95th birthday.   Thanks to his ideas, tens of millions of students around the world got their chance in higher education, and at a better life.  If you get a chance tomorrow, raise a glass to him.

March 15

The US Debt Freak-Out

If you read the US papers at all, you’ll have noticed a recent ratcheting-up of panic about student debt.  Take Charles Blow’s recent New York Times column, which describes US debt levels  as “staggering”, and having “long-term implications for our society and our economy, as that debt begins to affect when and if young people start families or enter the housing market.”

Some facts are in order.

It is certainly true that, in the United States, it’s possible to accumulate some absolutely staggering amounts of student loan debt, to no good purpose.  Law grads, in particular, routinely rack up six-figure debts, only to end up in positions with mid-five-figure salaries (do read Paul Campos’ Don’t Go to Law School (Unless) – it’s an eye-opener on this topic).  But those numbers are severe outliers.  In fact, among the 60% of American students who borrow, the average debt is about $27,000 – with median debt being somewhat lower.

Sound familiar?  It should.  Those numbers are almost exactly the numbers we’ve had in Canada since the turn of the century.  And though life isn’t as easy for young people with loan debt today as it was thirty years ago, it’s not as though the last decade’s worth of graduates are some kind of immiserated proletariat.  Against expectations, the rise in debt in the 90s didn’t reduce access (quite the opposite, actually), and it didn’t lead to a generation of debt peonage.  In fact, grads in their late 20s and 30s live pretty much the way they always have.  True, home ownership rates have fallen among the under-40s, but that has at least as much to do with a historic rise in house prices as it is does student debt.  In short, current levels of debt don’t have major behavioural or life-course consequences.

So, are Americans freaking out to no good purpose?  Only partly.  There are two good reasons why a similar level of debt in the US might be more consequential than it is here.  The first is that, with weaker safety nets, the consequences of falling into poverty are much, much worse.  The second reason is that the US student loan policy choices have been sub-optimal.

In Canada, thanks to Interest Relief (and later, the Repayment Assistance Program), students with incomes into the mid-$20,000s are exempt from making payments on their loans.  In the US, the threshold for loan deferment is, in practice, about half that, meaning that, unlike in Canada, some very poor borrowers can be required to make large loan payments.  America could have copied us in ensuring a good safety net for the poorest; instead, they chose to subsidize student loan interest rates across the board, regardless of need.

High levels of student debt are manageable.  It just takes good policy choices.

March 12

Measuring the Effects of Student Loans

Measuring the effects of student loans is brutally difficult.  It sounds simple, but it’s not.

Take a recent article called “Gender, Debt, and Dropping out of College“, published in Gender and Society, which made a small wave in access-conscious circles a couple of weeks ago.  Using data form the 1997 US National Longitudinal Survey of Youth, this article made two claims: first, that debt was positively correlated to completion up until a certain level of debt, after which the relationship reverses itself somewhat (though the relationship remains at all times positive); and, second, that this effect was greater among men than women – that is, at any given level of debt, the positive effect on graduation was more pronounced among women than men.

(Unfortunately, in the online commentary, the last point tended to be summarized as, “debt has more of an adverse effect on men than women”, which isn’t the same thing at all).

Now, debt is not an exogenous variable.   It doesn’t come out of nowhere.  It implies financial need, which, in turn, is a function of both socio-economic background and academic achievement.  It also implies a preference for borrowing over working.   Persistence is also a mutli-dimensional issue.  As generations of researchers have discovered, since Vince Tinto started working in this field nearly 40 years ago, there are a whole host of inter-correlated factors that affect persistence, of which finances are just one. So linking the two causally is a tall order.

One of the best papers ever on this subject was written a few years ago by University of Ottawa professor, Kathleen Day.  Using Canada’s Youth in Transition Survey, she found a small but positive relationship between student aid and perseverance in studies (though when “aid” was disaggregated into loans, grants, and scholarships, the effect was no longer detectable).   She then re-estimated her models to account for the possibility that aid and debt were both related to another unobserved variable, and found that the relationship between aid and persistence turned negative.  (That’s not to say aid is ineffective, but rather that the available data doesn’t permit a conclusive answer.)

Back to the Gender and Society paper, which has a variety of flag-raising methodological limitations.  There are no controls for student labour market participation, for a start.    Family income is treated as a trichotomous variable (high, medium, low) rather than a continuous one.  The paper also seems to not account for credits accumulated, or number of years enrolled, which is very odd.  Most seriously, it doesn’t account for the possible unobserved correlated variables.

Given this, I’d take the article’s conclusions with a truckload of salt.  It’s interesting, but far from conclusive.  We’re still a long way from understanding the effects of debt.

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