Why Lowering Interest Rates Won’t Fix the Student-Debt Problem

Lowering interest rates on student loans would not do much to lower defaults or encourage more young people to earn college degrees, according to a new analysis by the Brookings Institution.

The fact that cutting interest rates is being touted by Hillary Clinton, Senator Elizabeth Warren, and others in recent months isn’t exactly surprising in an election year. It’s more broadly politically palatable than, say, making college free à la Bernie Sanders. And it sounds nice at a time when college costs are ballooning and more so-called “nontraditional” students (often older, first-generation college-goers with families of their own, jobs to hold down, and bills to maintain) are pursuing higher education.

But cutting interest rates doesn’t make much sense, argues Susan Dynarski, a senior fellow at Brookings. An across-the-board cut, she points out, benefits all borrowers, even those who earn a lot of money and don’t need the help. Current income-based repayment plans, which borrowers have to opt into, create an interest subsidy that is a “poorly targeted, expensive tool for reducing loan default,” she argues, by effectively offering people of all incomes a subsidy at the end of their loan repayment period. (In 2013, Dynarski outlined a single, income-based loan-repayment plan that, like Social Security, would automatically vary payments based on the rise and fall of a borrower’s earnings.)

Instead, Dynarski invokes behavioral psychology and suggests that to really increase college-going in the United States, “tangible and salient incentives at the moment of decision-making are most effective in changing behavior.” In other words, actually lowering tuition or offering grants while someone is in college makes more sense than telling them they’ll have to pay less interest at some point in the future. And, she points out, cutting interest rates often saves people just a few hundred dollars, which isn’t much use for seriously distressed borrowers. “Cutting interest rates on student loans won’t get more students into college, and siphons off revenue from the grants than can do this important job,” Dynarski writes.

Lowering tuition or awarding grants might encourage more people to pursue college in part by simplifying the process of getting there. Nearly a quarter of aid recipients surveyed in a recent Institute for College Access and Success study said they had trouble completing the Free Application for Federal Student Aid (FAFSA), and almost half said they faced long lines at their school’s financial-aid office. But the same report, which looked specifically at community-college students, found that indirect costs, such as paying for transportation to school or housing near campus, often present more of a barrier to college completion than tuition itself, suggesting that grants need to be flexible.

Yet, as cash-strapped states tighten funding for higher education, it’s unlikely that many schools will lower tuition or seriously increase grants anytime soon. And while low-income students do have access to some funding in the form of the federal Pell grant currently, it is generally not enough to cover the cost of going to college and has restrictions on when and where it can be used, which has likely contributed to high dropout rates among recipients. Often, Pell recipients take out relatively small loans (compared to those taking out hundreds of thousands of dollars to pay for law school or a medical degree) to fill the gap between what the grant covers and the total cost. But due to a number of factors, including a lack of advising and poor academic preparation, these students are more likely than their peers who do not receive Pell to leave school before graduation but are still on the hook for paying back loans. It’s no surprise then, that borrowers with smaller loans have some of the highest default rates.

There’s also no good way yet for incoming students to gauge the return on investment of their education, including how much they might expect to earn after graduating with a particular degree from a particular school, as plans to provide some clarity in this area have met with fierce resistance. A recent survey of millennials with student debt from Citizens Bank found that 57 percent of young people surveyed would not take out as many loans if they had it to do again, and more than a third said they would not have attended college at all if they had understood all of the costs from the beginning.

That’s a particularly depressing finding, because, despite all of the issues, a college degree is still one of the best paths to success and financial stability, according to research by the Georgetown Center on Education and the Workforce and other think tanks. The fact that so many young people feel discouraged or confused by higher education in general is a clear sign that, whether by lowering tuition, providing grants, or something else entirely, more needs to be done to open the door to college. Simply talking about cutting interest rates isn’t going to cut it.