A new bill in Congress would amend loan limits for undergraduate students, graduate students, and parents. If implemented, the Promoting Real Opportunity, Success, and Prosperity through Education Reform Act (PROSPER Act) would allow for more competition for graduate students seeking loans as well as the potential for lower college tuition at expensive universities.
Introduced in December by Representative Virginia Foxx (R-NC), the PROSPER Act, with 21 sponsors, would increase the limit on unsubsidized federal government student loans for tuition for undergraduate students by $2,000 per year. In addition, it would limit the previously-unlimited graduate and parent PLUS loan programs. Graduate student PLUS loans would be limited to a total of $150,000 in loans for both their undergraduate and graduate programs. Parents receiving loans through the parent PLUS program would be limited to $12,500 per year per dependent.
Limits on graduate and parent loans would benefit private lenders of student loans. Currently, the Education Department has a near monopoly on the $100 billion per year student loan market. The Department is responsible for providing loans for nearly 90 percent of all new borrowers, leaving approximately $11.6 billion in loans for the private market.
Since 2006 when PLUS loans were not capped, the number of student loans provided by private lenders has decreased by 51 percent. Capping the amount graduate students and parents can borrow from the federal government would push students who require more funding for tuition to private lenders.
Stanford University economist Monica Bhole estimated that the introduction of PLUS loans for graduate students replaced private loans one for one, suggesting the PLUS loans crowded out banks and other private lenders. By adding caps to the loans, the private sector would have the ability to regain a larger share of loans. Additionally, Bhole found no increase in borrowing, suggesting that students were not forced to ration their credit in the absence of the PLUS loans.
Allowing private companies a larger share of student loans could reduce interest rates. With the federal government’s market dominance, Uncle Sam can charge a high interest rate on its loans to all borrowers. With more competition from private lenders, the government would have to lower rates—especially for people with good credit—in order to compete with lower bank interest rates.
The new limits would create winners and losers. Individuals with good credit would benefit more than individuals with poor credit. Because commercial lenders base their loans on creditworthiness, individuals with better credit history would be able to pay lower interest rates than those offered by the government.
The PROSPER Act may reduce the availability of private loans for students and families with poor credit history. Private lenders are more likely to lend to borrowers who are unlikely to default on their loans. Poor credit history signals an inability to pay loans off, making private lenders less likely to lend to these borrowers or more likely to charge high interest rates. For those with poor credit, this means that when these individuals reach the upper limit on the amount they can borrow from the government, they would have difficulty borrowing additional funds for tuition.
When students default on their federally-provided student loans, everyone loses. Currently, the Education Department charges an approximately 7 percent annual percentage rate on PLUS loans for both well-qualified borrowers and borrowers with a poor credit history. The Department relies on revenues from taxpayers and from borrowers who pay off their loans to cover losses from those who default. Limiting the amount people can borrow from the federal government would allow people with good credit to save on interest as well as reduce the burden on taxpayers when people default.
Although the PROSPER Act may limit the ability of people with poor credit to go to an expensive school, community colleges offer a good alternative. Students can complete their degrees in a fewer number of years, or they can transfer to a four-year institution after two years. In the long term, this policy may incentivize young adults and young parents to be more careful with their money if they know in the future that their child’s ability to go to college may rest on their creditworthiness.
Allowing commercial lenders into the market may also lower the cost of tuition. If colleges and universities know that students (through their parents) have the opportunity to receive unlimited loans from the government for tuition, there is no incentive to keep tuition low. Instead, they are incentivized to keep raising prices. If the student loan business becomes more competitive and more dependent on credit history, the number of students able to afford very expensive schools will decrease. A lower demand for expensive schools may encourage tuition reductions, benefiting all income levels.
A study completed by Mahyar Kargar and William Mann at UCLA found that when the Obama administration unexpectedly tightened credit standards on PLUS loan programs in 2011, schools that were more exposed to the change saw greater declines in tuition and enrollment compared to schools less exposed to the change.
Although the limits are a step in the right direction, some private lenders do not support the bill. The Consumer Bankers Association fears that higher limits in the undergraduate market would counteract benefits of caps in the graduate and parent PLUS loan market. A study completed by the Association estimates that the private loan market would be reduced by 16 percent annually.
Although the PROSPER Act is less than perfect, the bill is a step in the right direction to bring back competition to the loan market. In the long term, students and parents will be better off if interest rates and tuition bills are lower. The PROSPER Act could reduce the student loan burden on future generations of students.
Emily Top is a research associate at Economics21.
Interested in real economic insights? Want to stay ahead of the competition? Each weekday morning, e21 delivers a short email that includes e21 exclusive commentaries and the latest market news and updates from Washington. Sign up for the e21 Morning Ebrief.