Opinion: Graduate student loans should finally reflect their real cost

Our higher education system is broken. Families spend a fortune on degrees that no longer deliver the returns they once did. Whatever one thinks about the future of advanced degrees, they are clearly mispriced assets — a distortion that began in the student loan market.

The biggest imbalance shows up in graduate education, where borrowers carry the heaviest debt loads. Graduate students make up 25% of borrowers, but hold half of all loans. The federal government has long been the main lender, but the Trump administration is pulling back sharply and opening the door for private lenders. That will likely make graduate school more expensive because students will have to rely on costlier loans, but that may be a welcome correction.

Some graduate programs are risky bets, yet federal loans charge the same interest rate regardless of the field of study. Education can be a valuable investment, but students cannot make sound decisions without accurate price signals. If Alphabet Inc. and GameStop Corp. borrowed at the same rate, capital would not be allocated efficiently in the bond market. Why should university financing be treated differently?

That said, market pricing alone should not determine every loan term. Degrees that lead to teaching, for example, may offer smaller financial payoffs than MBAs, but they benefit society as a whole. I am not normally an advocate of government intervention, but one of the rare cases where it makes sense is when externalities cannot be priced properly. That is a major reason educational loans are subsidized in the first place.

But even a good thing can go too far.

Until recently, government loans effectively subsidized all graduate degrees. Some helped the broader economy, some paid off for the borrower, and others did neither. Yet they were treated alike in terms of risk and pricing, helping drive a surge in student debt and higher degree costs. Bringing private lenders back into the market could restore a sense of risk-based pricing and force borrowers to think more carefully about the debt they take on. Still, preserving the benefits of public subsidies while adding market discipline will require major changes in how education is financed.

The first of those changes is already underway. The One Big Beautiful Bill capped federal graduate student loans at $20,500 a year, beginning in July, with a $100,000 overall limit for most programs. For degrees the government classifies as professional — including clinical psychology, dentistry, law, medicine and theology — the caps rise to $50,000 annually and $200,000 in total, though why theology qualifies and a nurse practitioner program does not is a matter for debate, and lawsuits.

This could be a turning point because federal loans will no longer cover the full cost of tuition and living expenses at most private universities. Even some programs subject to the higher cap will face that gap. The shortfall is estimated at $8 billion a year.

In theory, setting different loan limits by degree is sensible because it pushes borrowers toward private financing. Students in the lower-cap programs now face two additional hurdles: they are more exposed to higher private-sector rates, and they cannot use the government’s income-based repayment plans, which can lead to partial loan forgiveness, for that share of their borrowing.

That should make students think more carefully about the value of the degree they are pursuing. If demand for certain programs falls as a result, universities may have to lower prices. There is already some evidence that this is beginning to happen.

Still, the new rules have shortcomings that should be fixed.

The degrees eligible for the higher professional cap are currently chosen in an arbitrary way and could easily become politicized. The government has already decided not to lend to programs that do not increase a student’s earnings; it could use similar evidence to set objective limits for other graduate degrees as well.

A more nuanced approach is also needed for degrees such as teaching or social work, which create positive spillovers. In these cases, the government could extend forgiveness to private loans once borrowers have worked in public service for 10 years or more, just as it already does for federal loans.

Rebuilding the private lending market is another major challenge. Before the Grad PLUS program was introduced in 2006, private lenders were effective at matching prices to risk. Grad PLUS allowed students to borrow what they needed on better terms, crowding out private lenders. It also separated borrowers from price signals and helped feed today’s student loan crisis.

Restarting that market will not be simple. Student loan debt carries a high risk weight on bank balance sheets. Before 2006, private student loans were securitized to offset that risk. Reviving securitization will take time because it depends on more detailed data than currently exists about credit risk across degrees and schools. The government may need to provide early credit enhancements to help the market grow enough to support securitization.

Economists Beth Ackers and Sarah Turner identify several other obstacles. Before Grad PLUS, private lenders used borrowers’ credit scores — or their guarantors’ scores — to set loan terms. That information is easy to obtain, but it is not enough: it disadvantages lower-income families and looks backward rather than forward. Some pre-Grad PLUS lenders also used estimates of future earnings by degree and field. That kind of data is essential for setting risk-based prices that students can actually afford, but gathering it in enough detail will take time.

Getting the private sector moving in a regulatory environment with limited data may also require universities to participate. Schools could partner with private lenders to subsidize loans or provide them directly. They have done so before, although they would likely need some form of government guarantee.

Bringing risk into higher-education loan pricing could reshape graduate programs by aligning incentives more closely at every level, as long as subsidies remain for degrees that serve the public good. What happens in graduate education could also become a template for pricing education more broadly and for pushing universities to take greater responsibility for their students’ outcomes. Education carries risk like any other asset, and when its price is distorted, bad choices follow.

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Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is author of "Worth the Risk: The Seven Myths That Keep Us From Taking the Chances We Need to Take."