How the Student Loans Started and the Changes That Got Us Into a Modern Crisis

America is in the middle of a student loan crisis.

Over the past five years, the amount of student-loan debt has surpassed credit-card debt to become the biggest area of non-housing debt in the United States. In the first quarter of 2016, Americans owed $1.26 trillion in student loan debt, compared to $1.07 trillion in auto loans and $0.73 trillion in credit card debt.

In the first quarter of 2016, Americans owed $1.26 trillion in student loan debt, compared to $1.07 trillion in auto loans and $0.73 trillion in credit card debt.

Those numbers are pretty unbelievable, aren’t they? They’ve grown so much that major news outlets have deemed it a crisis:

  • TIME magazine wrote an article titled, “Why the Student Loan Crisis is Even Worse Than People Think.”
  • The Huffington Post has an entire section of their website dedicated to it.
  • A particularly popular article on Slate titled “Betrayed by the Dream Factory” was shared more than 14,000 times on Facebook and received 3,500 comments.

Why has the outcry reached these levels at this point in history? It may have to do with the fact that, as Student Loan Hero CEO Andy Josuweit (@Josablack) points out, more students are in debt than ever. In fact, the number of borrowers has doubled in the past 15 years, he said. 

With these staggering numbers in front of us, it’s hard not to wonder what led to this point:

  • When were the first federal student loans offered?
  • Why did they come into existence?
  • How has legislation changed over the years?
  • What are the most significant points in student-loan history?

We’ll answer each of these questions by using our own research and interviews with student-loan experts. As we move into the first part of this article, you might be surprised to know that student loans came into existence because of outer space, not to make college more affordable.

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The Long, Colorful History of Student Loans - Infographic

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The First Federal Student Loans Ever Were Meant to Beat the Russians

Federal student loans – loans given to students by the government – can be traced back to the National Student Defense Loan program. 

Back in the 1950’s, the United States was locked into the Cold War with the U.S.S.R. The two countries were not only competing to gain further prominence as a world super power, but they were also battling it out to see who could be the first country to get to the moon.

President Dwight D. Eisenhower knew he had to build up the United States’ space program through education. The more students enrolled in science classes, the thinking went, the more well-trained personnel the U.S. would have to develop a successful space program.

So, in 1958, Eisenhower signed the National Defense Education Act (NDEA) to do just that. The NDEA provided student loans to students who wanted to enroll in fields of study helpful to the nation’s defense and space programs.

Robert Collins, Vice President of Financial Aid at Western Governors University and a long-time financial aid expert, took some time to talk with us about the NDSL and several other historic moments.

“Russia was going to put a man in outer space, so the U.S. was concerned,” he said. “They wanted to join in the race to develop a space program, so they created the NDSL to help students learn science curriculum to help develop the next rocket ship. That’s when it all started.”

The specifics of the student loan program were included in a section of the act called “Title II”.

When the program started in 1959, 24,481 students used the NDSL loans, with $9.5 million allocated to those students across 1,188 different educational institutions. By 1964, the number of students increased by nearly 1,000 percent and the money disbursed as loans increased to $119,500,000.

Does that sound familiar? Much like today’s scores of bloggers, journalists and students, we wanted to know if those loans actually paid off.

Did the program actually benefit our defense and space programs? To answer that question, we have to skip ahead to 2007 when the Science & Technology Policy Institute published a review of the outcomes of the program. The group talked about what Title II was intended to do and what the outcome actually was.

Their conclusion was that Title II was effective in providing a way to get to college for students who wouldn’t otherwise have a chance to enroll: 

“Before the passage of the NDEA, many students – even those who worked full time in the summer and part time during the school year – could not afford to attend or complete college,” the study said.

The program, on average, awarded students between $400 and $500 per year even though the maximum loan disbursement was $1,000 a year. According to the report, only about 5 percent of college students participated in the NDSL program.

However, the study pointed out that it’s really difficult to know if the government met their goal of boosting our space and defense efforts:

“Directly assessing the effect of Title II on people trained in the fields of science, mathematics, technology, and foreign languages is also difficult,” the report said. “Institutions were not required to keep records of NDSL recipients’ courses of study.”

The Higher Education Act of 1965 is the Moment Your Student Loans Were Born

The next big shift in the history of student loans came in the 60’s with the passage of the Higher Education Act (HEA).

The HEA created federal grants and loans for students beyond just defense-related subjects. Remember how Title II explained the student loans included in the NDSL program? In the HEA, Title IV is where lawmakers talked about student loans. And that’s where you’ll find the most significant (and probably most familiar) part of this act: the William D. Ford Federal Direct Loan Program.

Alexandra Hegji, an analyst for the Congressional Research Service wrote a great summary of the original 846-page HEA.

Her breakdown of why the act was passed goes like this:

“The Higher Education Act authorizes numerous federal aid programs that provide support to both individuals pursuing a postsecondary education and institutions of higher education.”

As we mentioned before, the HEA introduced loan (you have to pay them back) and grant (you don’t have to pay them back) programs. The loans were classified under the “Guaranteed Student Loan” program, or GSL. 

The act also introduced the Federal Family Education Loan (FFEL) program, in which private lenders (banks, etc.) could offer loans to borrowers. The government gave these private lenders subsidies in order to keep costs down. Sallie Mae and Freddie Mac, two notorious names during the Great Recession, are recent examples of these private FFEL loans.

Another important point: In this era of student loan history, there were multiple options for discharging (getting rid of) student-loan debt through bankruptcy.

You can consider the HEA the bedrock on which all of today’s loan programs are built…it’s pretty much the father of the modern system.

From 1965 onward, the history of student loans takes some serious twists and turns. To help sort out the various acts, legislation and changes, we’ve relied on a chart sent to us by Mark Kantrowitz (@MKant), a student-loan expert who has contributed to The New York Times and founded FinAid.org.

1976: It Just Got Harder to Get Rid of Your Student Loans Through Bankruptcy

The 70's brought with it one of the most hated aspects of the student loan program: the end of bankruptcy exception, a rule that allowed loans to be discharged in bankruptcy.

However, that year a set of new regulations were put in place that forbid you from discharging your loans through bankruptcy, unless: 

  • Those loans created an “undue hardship for the borrower and the borrower’s dependents”.
  • You had been paying them for at least 5 years.
  • Loans were granted by a nonprofit higher-education institution.

These regulations became part of the U.S. Bankruptcy Code in 1978

1980: Graduate Students Breathe Sigh of Relief With New PLUS Loan

Up until 1980, there weren’t many options for graduate students to take out loans from the government. That year, however, the Federal PLUS Loan Program was added to the lineup of student loans. 

PLUS loans were made available to graduate students or parents of dependents who were enrolled in undergraduate or graduate studies.

1987: GSL Becomes the Stafford Loan Program

Over time, several of the aid programs started in 1965 gained new names. For example, the NDSL loans we told you about earlier are now called Perkins loans. 

Perhaps the most significant name change came in 1987 the GSL was renamed the Federal Stafford Loan Program. As you’ll read in a few minutes, the Stafford program expanded as the years went on. At this time, however, Stafford loans were subsidized loans backed by the government.

1992: The HEA Amendments Fight Off Loans in Default

By the time the 1980’s rolled around, analysts noticed that not every student who took out one of the many loans offered was actually paying their loans back.

“Default rates were out of control,” Bob Collins said. “Congress was saying to themselves, ‘One in five students aren’t paying their loans back.’”

Bob brings up a good point: Congress was concerned. Why? Because every few years, Congress takes a look at the Higher Education Act to see if changes need to be made and to reauthorize it.

And when 20 percent of students aren’t paying up, it’s time to take action, especially when those who weren’t paying their loans back were successful doctors and lawyers.

“Congress … put in additional gatekeeping requirements as well as some oversight requirements,” Collins said. “They really put some teeth in the programs.”

Those requirements were part of the 1992 Higher Education Amendments, signed into law by President George Bush in July of that year.

The man behind the amendments was a Rhode Island senator named Claiborne Pell, whose name should sound familiar: Pell Grants.

Some of the most familiar changes in the ’92 amendments included:

  • A three-year limit on deferments based on economic hardship
  • Weed out schools with high default rates or abusive lending practices
  • Using the IRS to collect for loans in default

The outcomes of these amendments, Bob said, were positive.

“On a national basis, the default rates started coming down after that,” he said. “It put the programs in the right perspective.”

But weeding out the bad seeds wasn’t the only important aspect of the ’92 amendments. That year, Congress added an unsubsidized Stafford loan option, which meant students could receive loans no matter what their financial need was. However, unlike the subsidized Stafford loans, the government wouldn’t pay for interest accrued while a student was in school.

1998: Big Changes to Defaults, Payment Plans

Up to 1998, loans were considered in default if a payment hadn’t been made for 180 days. That changed in ’98, when Congress approved a slew of changes called the Higher Education Amendments of 1998.

According to the amendments, loans went into default after 270 days, giving students about three more months to try and resolve their account.

But lengthening the pre-default period wasn’t the only change; the amendments also included the addition of the extended repayment plan. Whereas borrows had 10 years to pay back their loans previous to the HEA of 1998, they now had the option to choose a plan that extended their payments another 20 years.

Like consolidation, however, the extended payment plan meant that students would pay more in interest over the life of the loan.

Another significant change in 1998 was the addition of the Teacher Loan Forgiveness, in which borrows could eliminate a certain portion of the student-loan debt if they taught in a pre-determined list of low-income schools.

While these three changes were, arguably, good for students, the final change made it even more difficult for students to get rid of their student-loan debt through bankruptcy. The amendments included the elimination of a borrower’s ability to have their loans discharged in bankruptcy if they’d made payments for at least seven years.

The 2000’s: Good, Bad and Ugly for Borrowers

The next decade of reform and legislation was probably the most influential in student loan history. The easiest way to think about this period of time is pre-recession and post-recession.

Pre-Recession Changes

This chunk of the 2000’s was pretty damaging for borrowers whose loans went into default. First, in 2001, the Department of Education implemented a plan to use of to 15% of a borrower’s social security payments to pay off defaulted loans.

Second, in 2005, a new bankruptcy act virtually eliminated any chance for students to discharge their private or federal loans in bankruptcy. That same year, the Supreme Court decided in favor of the government’s ability to use a portion of Social Security and retirement payments to pay defaulted education loans.

On the bright side of things, the government took a step in the right direction by enacting new regulations on behalf servicemembers. In 2003, the Servicemembers Relief Act was passed, capping student loans interest rates at 6 percent for those in active duty. The act also extended the military deferment time period to five years.

Also, five years after the September 11 attacks, the government extended loan forgiveness to parents and spouses of people who died in the attacks.

Another avenue for loan forgiveness opened up with the College Cost Reduction and Access Act of 2007, which stated that borrowers who made payments and worked in public service professions for 10 years could have their remaining balance forgiven.

The act also introduced income-based repayment plans that would eventually kick in two years later.

Post-Recession Changes

Since 2008, student loan debt has skyrocketed.

When the United States entered the Great Recession, states started cutting back funding for colleges and universities. As a result, educational institutions raised their tuition to cover the gap left behind by state money.

“In 2008 and 2009 … you’ll find that many states reduced their subsidies for higher education and secondary and elementary education, too,” Bob Collins said. “So what does that do? It raises the prices, so they had to raise their prices exponentially.”

Many experts point to this moment in history as an explanation for why tuition costs have increased so much over the past few years.

And, as a result, students have been taking out more loans than ever. According to the Federal Reserve Bank of New York, the country’s total student loan debt nearly doubled between 2008 and 2013.

The country’s total student loan debt nearly doubled between 2008 and 2013.

In 2010, student loan debt surpassed credit card debt and just two years later it surpassed car-loan debt to be the largest class of debt behind mortgages. To further concerns about a crisis, student loan debt topped $1 trillion in 2012.

As this growth in debt became more and more obvious, the United States government took action in a variety of ways, many of which benefitted the borrower.

In 2010, President Barack Obama signed the Healthcare and Education Reconciliation Act, which ended the FFEL program. This was a big deal; the federal government would no longer be paying private banks to service student loans. Not only did the act cut out the middleman, but it also freed up about $86 billion in taxpayer money.

Here’s what a White House press release said about the changes: 

“These reforms save the taxpayers $68 billion over the next decade by ending the subsidies given to banks and middlemen who handle student loans.”

A 2013 article in Salon pointed out that the third-party loan system was so toxic that politicians on both sides of the aisle despised it.

“Private banks reaped the sizable profits that these loans were generating,” freelance contributor Tim Donovan (@tadonovan) wrote. “Quite understandably, this was a wildly unpopular system.”

The second big win for students came in 2012, when the White House extended the Stafford loan interest rate of 3.4 percent for an additional year. The following year, changes to the way interest rates were calculated for Stafford and PLUS loans lowered the tax rates for 11 million borrowers.

Where We Are Now: A Lot of Debt, A Lot of Options

Over the past 10 years, student-loan debt has increased by huge amounts. At the same time, the federal government has added several different types of repayment plans to help students manage that growing debt. 

These opposing forces don’t seem to solve the student loan crisis we’re facing. 

Part of that is because a small percentage of borrowers are enrolled in payment plans based on income. In fact, Consumer Reports’ Donna Rosato said that while 51 percent of borrowers are eligible for income-based repayment plans, only 13 percent use them.  

Beyond the various ways you can repay student loans, there remains the issue of the rising cost of education. We touched on it earlier – states stopped funding their colleges and universities during the Great Recession. Yet that’s not the only reason, experts say, that college tuition is rising. 

One notion is called the Bennett Hypothesis, which was proposed by Bill Bennett, a student-loan expert and former education secretary for President Ronald Reagan. Bennett’s theory was colleges and universities raised their tuition because they knew the government would provide students the money to attend. 

Here’s how Bennett put it in a 2013 interview with The New York Times:

“If the federal government gives money, tuition goes up. If the federal government doesn’t give money, it goes up. Now, I think the availability of federal funding drives it up more quickly and more surely. Federal student aid makes it easier for colleges to do what they’re going to do anyway, which is raise tuition. There’s more money available.”

Rising costs and the debt crisis have made college students question whether or not it’s actually worth it to go to college.

According to statistics website College Data, the average budget for a college student to attend a state school was nearly $25,000 when all costs, including tuition, are included. Private schools averaged nearly $48,000 for one year of education.

That’s a ton of money. As a result, Student Loan Hero points out, the average monthly payment on a borrower’s student-loan debt is $351 if you’re between 20 and 30 years old. And the final blow? The class of 2015 graduated with an average of about $35,000 of loan debt, Market Watch’s Jillian Berman (@JillianBerman) reported in January 2016.

The crisis is real. Incoming college students have to make tough decisions about where they should go to school and how much student-loan debt they need to take out.

If the decision was purely a financial one, we’d recommend attending a community college to get your A.A., then head to a four-year state college/university to get your bachelor’s degree.

In the meantime, we encourage you to read our other articles about student loans. We’ve written an in-depth guide on how to avoid student-loan debt, as well as how to manage it. We’ve also created a guide to help you pay off your loans faster so you can achieve financial freedom.


More on Student Loan Debt:

Main photo credit: iStock.com/erhui1979


J.R. Duren

J.R. is an award winning journalist who uncovers the hard truths about personal finance, health and fitness through in-depth research and interviews with experts.


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