History of Student Loans: Origins

How education is funded and how students pay for it has changed significantly since the inception of the first American colleges. Postsecondary education was once free or very inexpensive, a far cry from the exorbitant sums now expected of students even at state universities. The student loan system that now saddles most students with significant debt is only 60 years old.

The history and evolution of student loans has been attributed to a series of social and economic developments, from changing enrollment demographics to the Industrial Revolution to the World Wars.

Should We Pay for College?

During the 2016 Democratic primary, presidential candidate and senator from Vermont Bernie Sanders both raised eyebrows and drew cheers for his contention that postsecondary education in the United States should be free of cost. In 2017, he introduced the notion legislatively as the College for All Act. The act aimed to “eliminate undergraduate tuition and fees at public colleges and universities” and included substantial reductions in student loan interest rates.

It’s not difficult to see how this struck many as implausible, even unimaginable.

College tuition costs are rising exponentially, with the average cost of tuition and fees and room and board at in-state public 4-year colleges standing at $22,180 for 2020-21, according to the College Board. That’s nearly triple what it was 50 years ago in constant dollars (20-fold in current dollars). At the end of 2018, student loan debt outstanding reached a staggering $1.68 trillion per the Federal Reserve. For most students, incurring some amount of loan debt to attain a college degree is a given. About two-thirds of 2020 graduates exiting with a bachelor’s degree carried a student loan debt burden.

Yet, free college tuition is not unprecedented. In fact, many early universities in the United States were free and stayed that way for decades. So how did we get from there to a system that requires students to go into significant debt before they have even begun their careers?

Free or Cheap: The Early Days of the American University

Many early American universities were philanthropically or governmentally funded and thus charged little in the way of tuition. Some fees and the cost of room and board were met by students and their families, but educational costs were nominal in many cases. Still, room and board could be steep, and the early incarnations of American higher education were thus restricted to the upper classes.

As the 19th century progressed, more institutions catering to middle-class students were established. The 1862 Morrill Act allocated funding for land grant schools in each state, further expanding the range of postsecondary options. Because a large proportion of students at these colleges were trained as educators and religious leaders, free tuition was justified as a public good.

Despite major changes in the ensuing decades, some state university systems, such as those in Florida and California, remained tuition-free into the 1970s and 1980s.

Rising Costs and a Changing Agenda

In 1870, some 63,000 students were enrolled in postsecondary institutions. This is the first year for which reliable statistics are available from the Office of Education, formed three years earlier. By the end of the first decade of the 20th century, this number had increased six-fold. Rapid industrialization, an economic boom and the potential to train for lucrative careers in the private sector profoundly altered the landscape of higher education.

No longer were colleges simply churning out public servants. They were training a new generation of careerists dead-set on profit. By 1920, 598,000 students were enrolled.

In light of these shifting attitudes, in 1927, financier John D. Rockefeller, Jr. issued a call for increasing charges to students (see page 41). He reasoned that the increasing benefits conferred to students ought to come at a reasonable price, particularly given the rising costs to institutions attempting to accommodate skyrocketing enrollment. He suggested the issuing of reasonable loans to students in need, to be paid back beginning ten years after graduation.

Though his idea never got off the ground, it presaged the growing costs in the coming decades and the increasing burdens on students. The Great Depression (1929-39), in particular, led to tuition increases as a result of decreases in state funding and private endowments.

The G.I. Bill

As World War II drew to a close, concerns about the fate of returning soldiers led to the 1944 passage of the Servicemen’s Readjustment Act, better known as the G.I. Bill. The bill provided funding that subsidized college education for servicemen, and provided low-interest government-backed mortgages and business loans.

A decade later, college enrollment had risen to 2.45 million students. This was due to both the number of G.I.s who availed themselves of the bill’s provisions and the expanding suite of available professional accreditations.

The bill thus had the effect of establishing the role of the government in facilitating the pursuit of higher education through financial assistance. In particular, the government-backed housing loans were a precursor to government-backed student loans that would later emerge as cornerstones of American higher education finance.

Early Student Loan Programs – History

The concept of lending students money to finance their education is in fact an ancient one. Though students at medieval universities were typically supported by their wealthy families and patrons, somewhat informal systems of loans were established for students who might need them.

At the University of Bologna, the oldest European university, groups of foreign students provided loans to their countrymen as needed during the 12th century. In 1240, a system was established at Oxford University wherein students would deposit valuables in a trunk known as St. Frideswide’s Chest as collateral for interest-free educational loans. This system expanded and persisted until the 16th century, when conventional lenders took over.

In the United States, universities such as Dartmouth and Princeton occasionally advanced students the cost of their education, which was later to be repaid, during the Revolutionary War period of the late 18th century. However, the first university to do so on a formal basis was Harvard, which established the Harvard Loan Fund in 1848. The fund was endowed by alumni and students could apply on the first day of class. The concept was soon taken up by other universities.

National Defense Education Act

The passage of the National Defense Education Act in 1958 was motivated in part by competition with Russia, which had launched the world’s first satellite, Sputnik, the year before. The purpose of the act was to bolster science, mathematics and foreign language education.

One of the act’s provisions was the creation of the National Defense Student Loan program. (This later became the National Direct Loan program and then the Federal Perkins Loan system.)

This was the first federally-backed loan system. It granted loans of up to $1,000 a year, with a total loan amount not to exceed $5,000. Loans were repaid over the span of a decade following graduation and carried a 3% interest rate. Teachers could obtain a certain amount of forgiveness — if they taught for five years, 50% of their debt would be cancelled.

The program facilitated a major increase in enrollment. By 1970, some 8.6 million students were enrolled in college.

The Higher Education Act

In 1965, the passage of the Higher Education Act moved student borrowing toward an intermediary system. The Guaranteed Student Loan (GSL) program, part of Title IV of the act, backed loans issued by private lenders with federal funds and a government guarantee. The government would repay the loans if students defaulted. These later became known as Stafford Loans.

When the act was reauthorized in 1972, it formed the Student Loan Marketing Association (known as Sallie Mae), a government-sponsored enterprise (GSE) intended to facilitate liquidity in the loan market. Sallie Mae privatized in 2004 and spun off Navient in 2014.

The Middle-Income Assistance Act of 1978 removed the income requirement for Guaranteed Student Loans, substantially increasing their availability to a large swathe of the middle class. (This was reversed in 1981.)

By this point in time, the foundations of the modern student loan system had been established.

Later Developments

During the 1980s, critics of the student loan system argued that the increasing distribution of student loans had enabled institutions of higher learning to significantly raise tuition prices. Among the most prominent proponents of this theory was Secretary of Education William J. Bennett. The theory, while popular at the time, has since been widely contested. And it had little impact on loan policy.

The passage of the 1992 Higher Education Amendments instituted an unsubsidized version of the Stafford Loan, identified as “Unsubsidized Stafford loans for middle-income borrowers,” again making them available to students regardless of income. The 1993 Student Loan Reform Act saw a renewed push for direct rather than guaranteed loans. The act also instituted an income-contingent repayment plan. These shifts were paralleled by further tuition increases and an increasing reliance on loans to pay for postsecondary education.

The use of guaranteed loans persisted despite the availability of direct loans until the financial crisis of 2008, which saw decreased faith in private creditors. Passage of the Ensuring Continued Access to Student Loans Act enabled private lenders to continue making federal loans despite problems in the capital markets. However, it wasn’t until the passage of the 2010 Health Care and Education Reconciliation Act that guaranteed loans were eliminated. The act mandated that all federal government student loans be obtained directly. Private lenders had to make their own loans, without involvement of the federal government.

This major policy shift allowed for increased grant funding and the reduction of income-driven payments. These changes constitute the basis of the current system.

The debate over the wisdom of this structure rages on. With federal and private student loans standing as the second-highest debt category as of 2018, the continued evolution of the student loan system is all but a certainty.

[Editor’s note: Originally published on January 18, 2019. Updated on October 26, 2020.]