Are Income-Contingent Loans a Good Idea?

Here’s an idea much in the news recently: the best way to finance higher education is through post-graduation payments by students based on their income.. Oregon made a splash with legislation calling for a pilot program along these lines; students would pay no tuition or fees while in school, but would repay the state a percentage of their earnings for twenty or more years afterward.

Those who make a lot will pay a lot, while those who make little will pay little. That idea certainly has “progressive” appeal.

In an essay on Inside Higher Education, Andrew Gillen, who is the research director at Education Sector, argues that if it were done right, an income-contingent lending (ICL) system would be a good thing for America. Why would it be good?

Gillen correctly says that it eliminates the possibility of default. “Borrowers,” he writes, “are never put in situations where they can’t afford to make their payments.” That would be “a huge stress reducer for students.”

Furthermore, adopting an ICL system would make college “more attractive for those segments of the population that currently avoid students loans.”

All true, but I’m not sold.

Why do we not find “income-contingent” lending in other markets? To my knowledge, no auto loans have ever made the payments contingent on the income of the buyer. No business loans vary with the profitability or lack of profitability of the firm that borrowed. No home loans are written such that the monthly payments fluctuate with the owner’s income.

We don’t see ICl elsewhere because competing lenders only concern themselves with maximizing the return on their funds. Capital doesn’t go to people who might not pay back all they’ve borrowed on time because of the opportunity costs – more profitable loans foregone.

It would be just as much a “stress reducer” if people with auto loans could pay less if they took a pay cut or lost their jobs entirely.  And if business loans were repaid to the extent that the business is profitable, that would no doubt make such loans more attractive for those considering a startup or expansion of an existing business, but who avoid such loans because they’re apprehensive about being able to repay.

I can see no reason why we should shield college students from the rigors of thinking through both the benefits and risks of borrowing for their education.  Doing so, on the other hand, encourages a “don’t worry about risk” mindset that is in large measure responsible for the nation’s disastrously debt-ridden state.

Even the best designed ICL system would tend to encourage students who ought find either higher education alternatives they can afford or not go to college at all to enroll because the deal seems so appealing: “If I make lots, paying back a percentage isn’t a big deal, but if I don’t, the payments won’t be too bad.” Yes, that reduces stress, but our concern instead should be with minimizing the number of bad decisions – whether going to college, buying a car, or taking out a mortgage.

ICL would probably keep more students in college than otherwise by reducing risk. Unfortunately, that will help to keep the higher ed bubble inflated a while longer. If individuals or charitable entities want to assist marginal students, that is fine, but a federal ICL program would do more harm than good.


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