Defending Income-Contingent Student Loans

Last week George Leef argued that my recent case for income contingent lending (ICL), a type of student loan where the monthly payment is a function of the student’s income, was off base. One of his main points was that if ICL is such a good idea, “Why do we not find “income-contingent” lending in other markets?”

Other types of loan payments generally don’t need to be income-based because they have collateral that can be repossessed if the borrower stops making payments. Since an education is intangible and can’t be repossessed, traditional student loans don’t have collateral. ICL remedies this by converting the future earnings of the borrower into the collateral for the loan. Far from being a deviation from normal lending, ICL just brings the standard concept of collateral to student lending.

George’s real problem with ICL, however, is that it would “help to keep the higher-ed bubble inflated a while longer” by shielding “students from the rigors of thinking through both the benefits and risks of borrowing for their education.”

Au contraire. It is the current system that deprives students of the tools necessary to rigorously evaluate the wisdom of borrowing. The information available to students about what they can expect to learn in college is all but nonexistent. In addition, the information about what they will earn after graduating is insufficient, with broad industry averages and subjective voluntary surveys being the only sources of even mildly useful information. To top it off, the government will lend to anyone at the same interest rate regardless of their college or major. In short, asking students to think rigorously about the risks of borrowing after we’ve withheld the three tools most necessary to do so is like asking Michelangelo to paint the Sistine Chapel without using scaffolding, brushes, or paint.

ICL with private lenders won’t fix the dearth of information about learning and earnings, but it will address the lack of price signals sent by interest rates. As I mention in the original piece:

The main advantage of private lending is that interest rates would no longer be one-size-fits-all. Currently, a stellar student in a field with many job opportunities (e.g., nursing) pays the same interest rate as a bottom-of-the-class student in a field with dismal job prospects (e.g., law) despite differences in the riskiness of lending to these two students.

With private [ICL] lending that would no longer be the case, and the stellar nursing student would be able to obtain a lower interest rate than a slacker law student.

A 30 percent interest rate on a loan for a D student studying underwater basket-weaving at Last Resort University will do more to curb inappropriate borrowing than anything else.


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