History and Background: Student Loans

When Student Loans Started in America

Students loans — and especially today’s widespread reliance on them — are a relatively recent phenomenon in the American higher education system. While the country’s use of student loans dates back to 1838 at Harvard University, it wasn’t until the late 1950s that the federal government got into the business of lending to college students.

The first federal loans were issued in 1958, as part of the National Defense Education Act, to support study in areas deemed critical to national defense. Loans were given to students by colleges, which were required to match the federal funding. Seven years later, the Higher Education Act of 1965 created a broader guaranteed student loan program. Modeled after a state-run program in Massachusetts, it was the first government loan system open to students regardless of their major. The government subsidized the cost of federal loans for qualified students, offering them a way to borrow with much better terms than they’d be able to find on the private lending market.

There were a few factors that spurred the creation of federal student loans: The GI Bill normalized the role of the federal government in college financing, as well as the policy of giving money to individual students rather than directly to institutions. College enrollment doubled between 1944 and 1954, as a wider demographic of students attended college. Politics played a role, too, in that loans were added into the Higher Education Act in 1965 to drum up support among Congress members who wanted a program aimed at helping the middle class pay for college.

Guaranteed Students Loans vs. Direct Student Loans

Federal budgeting rules at the time Congress created the lending system made a guaranteed loan program — where private banks supplied loans, but the government covered interest subsidies and losses if borrowers couldn’t repay — look more affordable than a direct loan program. One policy expert described it as “an economist’s nightmare and a politician’s dream come true,” because a guaranteed loan appeared to cost nothing in the year it was made.

But budget accounting rules changed in 1990, so that loans made directly by the government and loans guaranteed by the government had to be counted the same. And in 1992, the government realized it could save money switching to a direct loan system. That shift happened slowly until 2010, when guaranteed loans were completely phased out. During the transition, the Congressional Budget Office estimated that ending the guaranteed loan system would save up to $68 billion over a decade.

This is important for journalists to keep in mind when politicians posit that student lending would be better run if it were returned to private banks. Experts disagree, with examples here and here.

How the Size of the Federal Student Loan Portfolio Grew

When federal loans were created in 1965, they were never intended to be used as widely as they are today. Since the mid-1970s, when student borrowing began to grow, loans have increased from about one-fifth to nearly three-fifths of all available student aid from the federal government. Rising college costs in the 1980s and 1990s helped drive this increase, but so did a series of policy decisions, including:

• In 1978, the Middle Income Student Assistance Act opened subsidized federal loans to all students, regardless of financial need. The policy was repealed three years later, but volumes grew as middle and upper-middle income families who previously didn’t qualify took advantage of subsidized loans, where the government paid for interest costs while a student was enrolled. In 1980, Congress created parent PLUS loans, initially allowing parents to borrow up to $3,000 for their child’s undergraduate education.
• In 1981, Congress extended borrowing to graduate students. And in response to concerns about the rising cost of the student loan program to taxpayers, lawmakers created a loan origination fee of up to 5 percent, making loans more costly for borrowers.
• In 1992, Congress raised the borrowing limits for undergraduate students, and eliminated borrowing limits for Parent PLUS loans, allowing parents to borrow up to the full cost of their student’s attendance with a very minimal credit check. Congress also created “unsubsidized” loans, opening loans up to middle- and high-income families who didn’t qualify for subsidized loans. It labeled those loans “unsubsidized,” even though they have the same below-market interest rates and loan forgiveness options as “subsidized” loans, and are partially funded by taxpayers. The only difference is that they have a smaller tax subsidy because unsubsidized loans’ interest begins to accrue even while you’re in college, whereas that’s not the case with subsidized loans.
• In 2006, because many graduate programs cost much more than the $20,500 cap on graduate student loans, lawmakers made PLUS loans available to graduate students, who can now use those to borrow up to the full cost of attendance for advanced degrees.
• Finally, in 2008, annual loan limits for undergraduates increased by $2,000 to their current levels, as of mid-2021.
• Today, parent loans comprise a growing share of the federal loan portfolio, even as policy experts raise red flags about parents’ ability to repay. Lax program rules make it easy for parents to qualify for the loans, regardless of whether they can afford them.

For decades, the amount of federal loans disbursed climbed year after year, as college enrollment rose and loan eligibility and limits expanded. But that trend appears to have ended in about 2010. The 2019-20 academic year actually marked the ninth consecutive year of decreased annual borrowing. Analysts attribute the decline in part to a dramatic drop in enrollment in for-profit schools, many of which tended to load students up with loans.

Updated June 2021.