The frustrating reason college students miss out on the most suitable federal-aid loans

A new study sheds light on how the complicated design of student-aid programs affects borrowing decisions

As the student-loan debt bubble grows, lawmakers and consumer advocates are pushing for better counseling to help students make better-informed borrowing decisions.

But as a new working paper circulated Monday by the National Bureau of Economic Research shows, counseling can have a dramatic effect on the choices these students make — and not always in a beneficial way.

Researchers from the University of Illinois at Urbana-Champaign and the University of Maryland examined how students make decisions regarding the size of their potential loan.

The researchers performed a field experiment with students attending a large, anonymous community college. All students at the school were offered the maximum amount of eligible federal-loan aid.

The financial-aid office then identified students who had not made a loan choice by August — these students were randomly sorted into different groups, and each group received different information regarding student loans.

On the other hand, for some students who didn’t ever choose a financial-aid package because of the overwhelming choices that were available, their inaction could end up being beneficial, because it could help them avoid debt.

Students who received more information on what past students had borrowed became overwhelmed by too many options, the researchers said. Students who were unfamiliar with the borrowing process and students who had worse grades were more prone to such information overload.

Here’s what they found:

• Of the students sorted into the control group that received no email communication, 14% took out a loan, and 12% borrowed the maximum amount.

• Other students, meanwhile, received emails citing either the unconditional ($800) or conditional ($3,000) average annual amount that past students had borrowed — these amounts both being lower than the maximum that students were offered in loans. They were 11% less likely to take out any loans at all after getting that information.

• A third group of students was sent an email simply stating that a student could borrow an amount other than what they were offered. This information was shown to have no effect on how likely they were to borrow. “Simply providing information may not be sufficient to improve student outcomes,” the researchers wrote.

This study aligns with existing research pointing to how important it is to be careful when designing student-loan packages.

A study distributed last November found that students are far more inclined to opt for the student-loan repayment plan they are offered by default, even if it’s not the plan best suited to their financial situation.

And a growing number of consumer advocates are now arguing that the ballooning student-loan debt isn’t necessarily students’ fault. Instead, they argue that existing policies have pushed people toward debt and allowed the student-loan industry to grow and take advantage of students.

This blog post was written by Jacob Passy on Marketwatch