Sunday, May 13, 2012

What auto loans can teach us about student loans

If you were a recent high school graduate, worked hard, got decent grades, and wanted to borrow $20,000, you could spend it on one of two things: a new car or a college education.  One of those choices is a much better investment than the other.  But while it is almost universally understood that a college education is more valuable than a new car, it is also the case that the means of getting that education--a student loan--is widely feared while the means of getting the car--an auto loan--carries no such stigma.

There are big cultural reasons why this is the case: the contradictory fears that a college education is essential for success in life and inadequate to ensure that success, for example, or the nonsensical political debates about  student loan interest rates.

But I am more interested in the practical reasons that auto loans are accepted and student loans feared, because colleges and universities can do something about those practical considerations.  Here are five characteristics of auto lending that might be suggestive for student lenders. The characteristics share one factor that ought to be on the mind of people working to fix student loans: auto loans give people power to act in ways they see fit.  Student loans, at key points in the college process, make it more difficult, not less, to act.

  1. Markets in interest rates matter--I can borrow money to buy a new car at 2.94% from my local credit union.  Occasionally, manufacturers offer 0% interest.  If I had horrible credit, but was willing to follow a strict repayment plan I could still get a loan, albeit at a much higher interest rate.  In short, there is a market for auto loans dedicated to making it possible for all sorts of people to buy all sorts of cars.  There is no meaningful market for student loans--regardless of your background, career goals, or ability to pay, you pay rates set by a single lender, the federal government, and take out loans in amounts dictated by the federal government. (And because there is no real market for loans, the few private lenders in the business can set their rates even higher than the federal rates.) Markets, when they work correctly, empower people to make informed decisions.  The process of getting a student loan is disempowering--all the key factors are out of the buyer's hands--the rate, the amount borrowed, the source of the loan, its term of repayment.
  2. The size of the loan and the desirability of the purchase coincide--A new car is most desirable when it is new, and so its worth aligns with the amount owed.  As the car ages and its value declines, so does the principal.  As with cars, a college education is most desirable when it is new, before the hard work, the disappointment, and the frustration of choosing a major, writing a thesis, and facing up to the hard factors of life weigh in.  But unlike an auto loan, a student loan's principal is highest when the thing purchased--a college education--is at its end--the moment when satisfaction is often the lowest.
  3. It is the monthly payment that matters--When you take out an auto loan, the focus of the discussion is on the monthly payment.  This focus, of course, obscures the total cost of the loan.  But it also helps people budget, since they know that each month for the coming five years they have to pay that amount.  In student loans, the monthly payment is a moving target until after graduation.  That fact makes budgeting difficult and forces soon-to-be-graduates to make decisions about their futures in a context of uncertainty.
  4. There is a secondary market for the loan and for the purchase--If you borrow to buy a car, and then decide that the car isn't for you, you can sell it. Selling the car allows you to either invest in another car or pay off your loan early.  Or, if you keep the car, other people can use it--brothers, sisters, friends.  But there are no secondary markets for college educations or student loans.  The loan you take out is yours.  You cannot share its amount with a family member.  Nor can a friend take classes paid for by your loan. So the social benefit of a student loan and a college education are blunted by the way the loan is constructed.
  5. An auto loan buys a car; a student loan does not buy an education--You buy a car because you need a car.  The thing purchased is directly tied to the money borrowed.  But a student loan really buys time in the classroom, not learning or an education. There are no guarantees; you cannot return the education if it isn't working, or get it repaired under warranty. For this reason, if time in college does not lead to learning, the price of the loan seems out of alignment with the value of the thing purchased.
It is my sense, then, that if the government is going to reform student lending, or if student activists are going to take up the issue, that they look to the auto business, where loans align with desires, serve social purposes, come with clear information, and provide freedom to act.


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