CHAMPAIGN, Ill. — Student loan amounts listed in community college financial aid award letters not only nudge students toward borrowing, but the offers of financial aid also lead to better academic results, according to research co-written by a University of Illinois expert who studies the nonprofit sector and higher education.
“Nudge-induced borrowing” increased students’ grade point averages and the number of credits they earned by roughly 30 percent in the first year of the intervention – and in the following year, it increased transfers to four-year colleges by 10 percentage points or nearly 200 percent, says a new paper from Ben Marx, a professor of economics at Illinois.
In the paper, Marx and co-author Lesley J. Turner of the University of Maryland estimate the impact of student loan “nudges” on community college students’ borrowing and provide the first experimental evidence of the effect of student loans on educational attainment.
The authors found that students who were randomly assigned to receive a nonzero loan offer were 40 percent more likely to borrow than those who received a zero-dollar loan offer or didn’t have loans mentioned in the award letter.
“We randomized the students between two types of financial aid award letters, only one of which showed a nonzero student loan,” he said. “Colleges call these ‘loan offers,’ and they’re what economists call nudges because they don’t affect the set of available options – in this case, the amount that the student is allowed to borrow. We found that the group that gets selected to receive the letter with the nonzero offer of student loans does much better in school.”
Colleges can decide how much loan aid to offer in financial aid award letters; nearly all four-year institutions show students the maximum amount of loan aid for which they are eligible. By contrast, community college loan policies are not uniform in how much loan aid they show to students.
Regardless of the number that a college lists in the award letter, a student must take proactive steps to obtain a loan. The amount that a student is allowed to borrow depends on a federal formula, not on the college attended or the “offer” it makes, Marx said.
“The loan offer often has nothing to do with the student’s eligibility for federal loans,” he said. “It’s just a number chosen by someone in the college’s financial aid office. When that number is a zero, or when loans aren’t mentioned in the award letter, that appears to give students the mistaken impression that they can’t get loans.”
For the average student, offering a loan in the award letter appears to make the student better off, despite the additional debt, Marx said.
“Other research has found that completing more credits at a community college and getting into a university both increase a person’s later earnings,” he said. “On average, these earnings gains appear to be worth far more than the amount of additional debt the student takes on. That’s true even without accounting for any earnings gains due to increased grade point averages or potential increases in the probability of graduating, which we’re continuing to track as the students progress through college.”
From a policy standpoint, offering a loan in a student’s financial aid award letter is a potentially low-cost, high-reward approach to increasing educational attainment in the U.S., Marx said.
“For the college, it essentially costs them nothing except the ink on the paper,” Marx said. “From a societal perspective, there is some cost in that not all students will repay their loans. But the cost-benefit analysis says you get an additional eight credits completed for every $1,000 in un-repaid student loans. That’s about eight times what you get per $1,000 expenditure from some of the most promising grant programs that we’ve seen.
“If the goal is to increase educational attainment in the U.S., then this is one of the cheapest ways we’ve seen to do it.”
Although it’s low cost for the government, it’s certainly not a free lunch for the student, Marx said.
“In the end, you are still saddling students with debt,” he said. “Some of them might not be able to translate these resources into improved academic performance and earnings, but it appears that for the average student it’s going to be more than worth it. In future work, we hope to get a better sense of whether some groups of students are more likely than others to benefit.”
By giving them this nudge to borrow money, students might feel that they have more “skin in the game,” Marx said.
“It’s a question we get a lot: ‘Why does this increase attainment?’ I would say there are two broad categories of explanation,” he said. “One would be the incentive explanation. If you’ve got more debt to repay, then that may create an incentive to study harder.”
The other would be a liquidity explanation.
“Once students have more resources, they’re able to do better in school,” he said. “A lot of these students are working while they’re going to college. If they don’t have to work as much or worry about how they’re going to pay the rent or put food on the table, that may allow them to focus more on their studies.”
The findings are relevant for colleges, policymakers and future research on the effects of nudges, Marx said.
“Over 5 million students attend colleges that do not offer loans in financial aid award letters, and nearly 1 million more attend colleges that do not participate in federal loan programs,” he said. “Our findings suggest that these nudges are a low-cost way of potentially boosting someone’s educational attainment and, by extension, lifetime earnings.”
The research was supported by the Lumina Foundation, ideas42 and the Russell Sage Foundation.
The paper was accepted for publication in the American Economic Journal: Economic Policy.
Editor’s notes: To contact Ben Marx, call 217-300-1435; email benmarx@illinois.edu.
The paper “Student loan nudges: Experimental evidence on borrowing and educational attainment” is available online.
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