Changing the Cost of Federal Student Loan Take-up: Evidence from the FFEL To Direct Loan Program Transition

Although federal student aid currently disburses more than $130 billion to 14 million students annually, students primarily cite financial difficulties as their reason for dropping out of college. In this paper, I use subtle differences in the federal aid application process to study how small costs affect student borrowing behavior by taking advantage of a policy change in which schools transitioned from the Federal Family Education Loan (FFEL) Program into the Direct Program. Because students must make an additional active decision under the FFEL system that is not required in the Direct program, marginal students may be less likely to borrow than they would at Direct schools. Using variation in the timing of switches by schools from the FFEL into Direct Program in a difference-in-differences framework, I find a significant increase in federal loan take-up rates under the Direct Program of about 5 percentage points. Additionally, average loan amounts among Direct loan borrowers are smaller, consistent with a lower fixed cost inducing students with smaller optimal loan amounts to borrow. I find no evidence of changes in enrollment composition or other school policies that would result in this increase in borrowing. Finally, I use Direct loan program status as an instrument for loan take-up and find suggestive evidence that federal loan use increases retention. ∗Department of Economics, University of Wisconsin-Madison. Email: [email protected]. I am especially grateful to Christopher Taber, Karl Scholz, Jesse Gregory, Anya Samek, and Justin Sydnor for their invaluable discussions and guidance. I also thank seminar participants from the UW-Madison Public Workshop for their helpful comments.