A History of Student Loans

A boom in higher education demand in the late 1970s saw cooperative problem-solving between the private and public sectors to address a key constraint: funding.

A History of Student Loans
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This is the first in a series of posts examinging the student loan system in the USA.

A boom in higher education demand in the late 1970s saw cooperative problem-solving between the private and public sectors to address a key constraint: funding. Institutions for higher education expanded services, and therefore costs, to meet growing demand. As costs grew, so did tuition, and society faced the challenge of ensuring the demand for higher education did not reduce its accessibility based on income. The federal student loan programs created to address this imbalance were well intended but have broken. Though enrollment increased dramatically over the last several decades - the growth in the cost of tuition has outpaced growth in wages - resulting in the $1.8 trillion student loan crisis. Below we summarize the evolution of legislation governing federally funded loans for higher education - all the way from the GI Bill of 1944 to the CARES Act of 2020.

The Path to $1.8 Trillion


The GI Bill

Rehabilitate the armed forces into the workforce

The G.I. Bill was transformative for higher education. The following decade saw a doubling in higher education enrollment. This is the first time the federal government claimed the role of financing and administering financial aid for higher education.


National Defense 

Education Act

Recruit smart people into federal research programs

The scientific arms race spurred by the Cold War pushed the federal government to administer financial aid to students based on academic merit or interest in defense-critical fields of study. Loans were issued directly to students and widespread adoption led to expansion of eligibility beyond specific fields. By 1960, 30 percent of college-aged individuals were pursuing higher education.


Higher Education Act 

of 1965

Expand eligibility to include more Americans

The HEA established the guaranteed loan program (GSL) and introduced need-based grants. Under the GSL, lending responsibility was placed in the hands of private underwriters. The federal government reduced risk for the private lenders by subsidizing interest payments and guaranteeing the loans in the event of default. The HEA laid the foundation for how higher education is financed today. Despite a federal guarantee, the high administrative costs and illiquidity of student loans kept private underwriting relatively unattractive.


Higher Education Amendments of 1972

Make programs attractive for private lenders

To address the illiquidity of student loans and encourage participation among private underwriters, the Student Loan Marketing Association (Sallie Mae) was established as a government-sponsored private corporation. Sallie Mae became the secondary market and warehousing facility for insured loans. With a secondary debt market and the risk of default nullified by federal guarantees, private underwriting became very attractive.


Higher Education Amendments of 1976 

Make collection of bad debt more efficient

The combination of loose vetting of lenders and poor repayment infrastructure sparked growth in loan default rates. In response, amendments to the HEA sought to expand the system of guarantor agencies and improve collection rates. Plans to incentivize States to establish student loan guarantee agencies were created and the Commissioner of Education was authorized to contract with private businesses, State student loan insurance agencies, or State guarantee agencies for recovery of defaulted loans in the Federal direct insurance program. 

Instead of fully addressing why default rates were spiking, the government introduced more efficient mechanisms to collect on bad debt. This is the first indication of a well intended system starting to break as the focus moved from access to higher education to profits for lenders.


Middle-Income Student Assistance Act (MISAA)

Relax eligibility and allow lenders to expand their addressable market at even better returns.

Pressure to refocus efforts on expanding access to federal aid continued and in 1978 the Middle-Income Student Assistance Act (MISAA) removed income requirements on guaranteed loans. This allowed any student to qualify for subsidized loans. Total federal loans issued maintained an annual average growth rate (AAGR) of 25 percent from 1977 to 1980. Private lenders, enjoying returns on risks held by borrowers and taxpayers,  to relax eligibility requirements and expand market opportunities.

The very next year, Congress passed an amendment to provide private lenders favorable rates on guaranteed loans by removing the previously held rate cap and pegging student loan rates as a percentage above Treasury bills. This allowed returns to private lenders to be more closely tied to markets during an era when the national economy saw double digit inflation and high interest rates. Together, these conditions led to significant growth in loan volume and federal costs.


Revenue Act

Try to reduce costs by creating incentives for employers to foot the bill

A full 13 years of blown federal budgets and crippling default rates following the HEA of 1965, the government sought to distribute the costs of higher education.The Revenue Act marked the first initiative to involve employers in this incentive system by excluding "educational assistance" provided by an employer from the gross income of an employee. The provision had a sunset clause of 1984, was extended several times, and was permanently extended in 2001 by the Economic Growth and Tax Relief Reconciliation Act. 


Higher Education Amendments of 1980

Attempt to correct mistakes but expand eligibility by lending directly to parents

The 1980s opened to budget cuts and reconciliation under the new Reagan administration. The main provision of the MISSA was repealed and need became a condition to receive guaranteed loans once again. The reauthorization also established the Parent Loans for Undergraduate Students (PLUS) program. State agencies, nonprofit private institutions, and eligible lenders were authorized to issue loans directly to students unable to obtain a federally guaranteed loan. These alternative loan sources would be funded via an advance from Sallie Mae.


Higher Education Amendments of 1986

Give lenders more power and pass more responsibility to the borrower

Sustained high rates of default among student loan borrowers led to an enhanced focus on the collection of bad debt. The HEA amendments of 1986 gave guarantor agencies the contractual right to make claims against the federal government on defaulted loans. The amendments also allowed garnishment of wages in the event of default and authorized the Department of Education (ED) to sell defaulted loans to collection agencies under specified conditions. By 1989, the national default rate exceeded 30 percent.


Higher Education Amendments of 1992

React and cut costs by increasing the burden on the borrower then try to find ways to help them pay for it

The 1992 reauthorization of the HEA introduced unsubsidized loans to the Stafford Direct loan program. The amendments also revised provisions for repayment period calculations and required lenders to offer borrowers a graduated or income-sensitive repayment schedule option. The Secretary of ED was directed to: (1) undertake a program to encourage private and public employers to assist borrowers in repaying student loans under title IV, including options for payroll deduction and loan repayment matching under employee benefit packages; (2) publicize repayment models deserving recognition; and (3) make recommendations to appropriate congressional committees on changes to statutes that could encourage such efforts. Total annual federal loans issued jumped by 34 percent in 1993 and again by 33 percent in 1994. 


Student Loan Reform Act

Attempt to correct mistakes by getting involved in eligibility criteria but fail because of previous powers granted to lenders

Deeming direct federally underwritten loans to be more efficient, legislators planned a five-year transition period to end the Federal Family Education Loan Program (FFEL), the original GSL program, to a new Federal Direct Student Loan (FDSL) program (to be later renamed after William D. Ford). This marked the transition away from private underwriting of guaranteed loans to loans issued directly from the federal government. However, the transition out of the FFEL spanned almost 17 years and officially ended in 2010 under the Health Care and Education Reconciliation Act. From 1992 to 2004, the cumulative taxpayer subsidy costs were $39 billion for FFEL loans compared to $3 billion for Direct Loans.


Taxpayer Relief Act

Try to absorb some of the cost to the borrower

The act created two new tax credits, established education IRAs, and added a deduction for interest payments on student loans.


Higher Education Amendments

Reel in the lenders and try to do good by the borrower

The amendments of 1998 required guarantor agencies to contribute funds to (1) a Federal Student Loan Reserve Fund, which is invested in federal obligations or similar low-risk securities and (2) an Agency Operating Fund, with such funds to be invested at the guaranty agency's discretion in accordance with prudent investor standards. Additionally, incentives to prevent default were given to loan servicing agencies via a compensatory fee for loans brought back to repayment status from delinquency. The amendments also required lenders to notify borrowers of the availability of an income-sensitive repayment option. Lenders start deepening relationships with educational institutions for referrals and partnerships with attractive fees and kickbacks.


Economic Growth and Tax Relief Reconciliation Act

Realize employers are driving the default rates down so increase tax incentives for them to continue doing so

Expansion of employer participation incentives came in 2011 with the allowance for corporations to contribute to education IRAs. The act also permanently extended the exclusion from gross income of employer provided educational assistance.


Deficit Reduction Act

Tighten up the lending and collection process; make things more transparent for the borrower

Minor adjustments to improve the overwhelming issues with the financial aid system were made through the early 2000s. The Deficit Reduction Act of 2005 required the Secretary of Education to offer direct consolidation loans to eligible borrowers who have been denied consolidation loans or consolidation loans with income-sensitive repayment terms by an eligible lender. Increases, from 10% to 15%, the maximum portion of disposable wages for any pay period which may be garnished to repay a student loan under HEA (unless the individual consents to a greater portion).

National Outstanding Student Loan Debt (2006): $523.38 billion


Higher Education Opportunity Act

Realize lenders are finding loopholes so address these directly and reduce burden on the borrower

As predatory lending practices became a legislative focus amidst a crashing subprime mortgage market, the federal government sought to increase borrower protections across the board. The HEOA required private student loan lenders and higher education institutions to abide by the Truth in Lending Act. To protect borrowers the act prohibits institutions from: (1) entering into revenue sharing agreements with lenders; (2) assigning a first-time borrower's loan to a particular lender or blocking a borrower's selection of a particular lender or guaranty agency; (3) requesting or accepting lenders' offers of funds for private student loans in exchange for business concessions or status as preferred lenders of title IV loans; or (4) requesting or accepting lender assistance with call center or financial aid office staffing, except in certain emergencies. The act also prohibits lenders from making such offers. In addition, the act targeted higher education institutions to ensure proprietary institutions earning less than 10 percent of their revenue from non-financial aid sources (the 90/10 rule) were sanctioned. 


Private Student Loan Transparency and Improvement Act

Increase oversight and further regulate lenders and educational institutions

To impose further consumer protection and disclosure requirements on private lenders, a separate act was passed and private education lenders became prohibited from: (1) offering or providing gifts to higher education institutions, or institutions from receiving them, in exchange for loan business advantages; (2) revenue sharing with institutions; (3) using IHEs' names or symbols in marketing their loans in a manner that implies that such IHEs endorse the loans; or (4) imposing fees or penalties on borrowers prepaying their loans.

National Outstanding Student Loan Debt (2008): $675.95 billion


Health Care and Education Reconciliation Act

Reduce incentives for lenders to profit from unsavory lending practices

After 17 years of administering a costly guaranteed loan program, the FFEL was officially shut down in 2010 and a shift to the direct loan program was made in full. The act directed the Secretary of ED to: (1) award DL servicing contracts to nonprofit servicers that meet certain federal standards and have the capacity to service their loan account allocation; (2) allocate the loan accounts of 100,000 borrowers to each of the nonprofit servicers; and (3) establish a separate pricing tier for each of the first 100,000 borrower loan accounts at a competitive market rate. The act also permits the Secretary to reallocate, increase, reduce, or terminate a nonprofit servicer’s allocation based on the performance of such servicer.


American Taxpayer 

Relief Act

Reduce tax burden for the borrower

Tax provisions relating to individual taxpayers, including the tax deduction for qualified tuition and related expenses, are extended.

National Outstanding Student Loan Debt (2013): $1.05 trillion


Coronavirus Aid, Relief, and Economic Security Act, "CARES" Act

Reduce burden for the borrower and increase tax incentives for employers helping borrowers

Most recently, the economic impacts of the Covid-19 pandemic exposed the financial burden many American households face despite the previous decade of national economic growth. The act expands the definition of "educational assistance" to allow payments made to employees or lenders of principal or interest on qualified education loans tax deductible by the employer and not included in gross adjustable income among borrowers until January 1, 2021. The act also suspended all payments due on Federal Direct Loans and Federal Family Education Loans held by ED through September 30, 2020 and established that no interest shall accrue on such loans to provide immediate relief to student loan borrowers.

National Outstanding Student Loan Debt (2021): $1.8 trillion

Almost 70 years ago, our federal government made an effort to improve access to education by lowering financial barriers to entry. The effort to attract private lenders to share the risk and rewards ended up creating incentives for the lenders and educational institutions at odds with the original intent. Difficult repayment experiences increased the default rates leading to declining trust in the programs. Attempts to reform the growing student debt crisis struggled with political and private interests keeping costly and inefficient programs like FFEL alive for decades while private parties profited. By the time legislators started taking action again in the mid 2000s, the student loan debt programs were more burdensome than empowering. Efforts to right the mistakes and focus programs on education are admirable but require more care and broader provisions.

In our next post we look at the asymmetry between the cost of education and how society rewards it.

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