Your Guide to the Looming Battle over Student Loans

By BRIANNA EHLEY, The Fiscal Times
May 30, 2013

Congress has one month to reach an agreement before interest rates on new federally subsidized student loans double to 6.8 percent. For once, both Democrats and Republicans see the increase as a problem that needs to be solved. As expected, though, they have very different solutions, each with their own benefits and shortcomings.

President Obama emphasizes the importance of college affordability, but a Fidelity Investments survey shows that new graduates are getting stuck with $32,000 in debt — a staggering sum even before interest costs are included.

House Republicans want manageable interest rates, but they also want to trim the deficit and in some cases have zero sympathy for college students who face skyrocketing tuition expenses and little choice other than taking on loans.

“I have very little tolerance for people who tell me that they graduate with $200,000 of debt or even $80,000 of debt because there’s no reason for that,” Rep. Virginia Foxx (R-NC), the co-sponsor of the GOP bill, said on a radio show last month. “We live in an opportunity society and people are forgetting that. I remind folks all the time that the Declaration of Independence says ‘life, liberty, and the pursuit of happiness.’ … You don’t just sit on your butt. You don’t have it dumped in your lap.”

Under current law, Congress sets the rates on Stafford loans, something lawmakers now want to change. When interest rates on the federally subsidizes loans were set to double last summer in the heat of the presidential election, both parties came together to offer a one-year extension.

If lawmakers fail to reach a compromise and the rates double on July 1, students who maxed out the subsidized loans over five years —racking up $23,000 in principal — would pay $12,598 in interest to repay the debt, according to the Congressional Research Service. Interest payments would shrink to $7,965 if the interest rates stayed at the current 3.4 percent.

Federal Stafford Loans make up about 75 percent of all student loans. There are two categories: subsidized loans that are available to low-income students with a relatively low interest rate of 3.4 percent; and unsubsidized loans made available to students in all income levels that carry an interest rate of 6.8 percent.

About 9.4 million students have obtained the low-income loans, each borrowing an average of $3,645. Students qualifying for these loans don’t have to pay interest while still attending college. About 8.8 million students are using the unsubsidized loans, and have borrowed on average $4,247, according to CollegeBoard.org. They are required to pay interest on their loans while attending school.

There are other federal program options, including Pell Grants, which are available to low-income students. About 5.4 million students use them each year.

About a quarter of student loans come from private lenders such as Sallie Mae, Wells Fargo and Discover Financial Services. These organizations typically offer fixed-rate loans for undergraduates that vary between 5.75 percent and 12.875 percent, depending on credit history, according to the Consumer Financial Protection Bureau.

The House passed their bill last Thursday, but it will never clear the Senate or Obama. Here’s a breakdown of the competing proposals, warts and all, and what it means for the class of 2017:

The Republicans’ Plan: There are two big flaws with the House Republican plan to tie the interest rate on all Stafford loans — subsidized and unsubsidized — to the yield on the 10-year Treasury, plus 2.5 percentage points.

For starters, the interest rate would reset every year, forcing grads to also overhaul their personal budgets each year, depriving them of the certainty that comes with a fixed rate.

Secondly, students would probably pay more in interest than they currently do. The rates would be at 4.4 percent this year, 5 percent in 2014 and jump to 7.7 percent in 2023, according to the Congressional Budget Office. The one positive is that rates would be capped at 8.5 percent.

According to CRS, students who borrow the maximum amount of subsidized and unsubsidized Stafford loans over five years would pay $14,430 in interest under the Republican’s plan. That’s $1,832 more than if rates simply doubled as planned.

Republicans estimate that their bill would annually bring in around $3.7 billion of extra revenue, which would go toward paying down the federal debt.

President Obama’s Plan: Like the Republican’s bill, Obama wants the student loan interest rates to be based on the 10-year Treasury, but they would remain fixed over the life of the loan. And the premium over the Treasury yield would be a much more modest 0.93 percent.

Under Obama’s plan, the CBO projects that Stafford loan interests rates would be at 3.45 percent in 2014.

However, his plan does not include the cap that Republicans installed. So theoretically, if interest rates on government debt exploded, Stafford loans would become unaffordable for much of the country as well.

Senate Democrats’ Three Plans: In a sign of the divisions that abound, Senate Democrats have three different proposals.

There is the stall tactic from Sens. Tom Harkin (D-IA) and Harry Reid (D-NV), which will likely reach the floor because it has the imprimatur of the Senate majority leader. Their measure would keep the Stafford loan rate at 3.4 percent for the next two years, giving them more time to determine a long-term solution to student loan interest rates through the reauthorization of the Higher Education Act. The bill would cost $8.3 billion over two years and — given the state of gridlock — guarantee that the problem crops up again soon.

There is the low-interest solution from Sens. Dick Durbin (D-IL) and Jack Reed (D-RI). Their bill ties the rates to the 91-day Treasury rate, plus a percentage that would be determined by the Education Secretary in order to cover administrative costs. It caps interest rates at 6.8 percent.

Finally, there is the grandstander from Sen. Elizabeth Warren (D-MA). She introduced a (mainly political) proposal last week that would set student loan interest rates at the same level that banks receive from the Federal Reserve — 0.75 percent.

Of course, the Fed rate is meant to influence how money circulates through the economy, an entirely different purpose than other forms of lending.

As Matthew Chingos at the Brookings Institution points out, Warren’s proposal should “be quickly dismissed” since it “confuses market interest rates on long-term loans (such as the 10-year Treasury rate) with the Federal Reserve’s Discount Window, which is used to make short-term loans to banks.” Warren’s proposal also doesn’t factor in administrative costs and the default risk — at least 5.9 million borrowers — that increase the costs of the federal student loan program.