Will Student Loan Interest Rates Double?

NEW YORK (MainStreet)—While a bill introduced last week by recently-elected Senator Elizabeth Warren (D-Mass.) -- her first -- to cut the rates on federal student loans was a make-good on a campaign promise, it is part of a legislative land rush in Congress aimed at fixing rates, coming from both sides of the aisle -- and the White House.

Presidential candidates Mitt Romney and Barack Obama were working the same issue about a year ago, leading to a one-year extension of the 3.4% interest rate on subsidized federal student loans. Students lobbied hard against a scheduled increase, and the Obama administration extended the current rate for an additional year.

Also see: Young Student Loan Borrowers Are Bagging the Home Mortgage and Auto Markets

That rate expires on July 1, when it jumps from 3.4% to 6.8%.Republicans in Congress have responded with HR 1911, the Smarter Solutions for Students Act.

"We've got to stop kicking the can down the road with short-term fixes to this interest rate problem," said John Kline (R-Minn.), the Chairman of the House Education and the Workforce Committee, referring to the prospects of another temporary, one-year extension. "The Smarter Solutions for Students Act is a lasting solution that will serve the best interests of students and taxpayers. Our proposal ensures that millions of subsidized Stafford Loan borrowers will not see their interest rates double this July, and other borrowers will actually have their rates reduced." Kline said that politicians would get out of the business of calculating student loan interest rates, a solution also proposed in the Obama administration's Fiscal Year 2014 budget plan.

The House Republican plan would set interest rates for Stafford undergraduate loans at the 10-year Treasury yield plus 2.5 percentage points. Rates would rise with the market, but would be capped at 8.5%. For PLUS loans, where parents sign for student borrowers, the rate is based on 10-year the Treasury yield plus 4.5 percentage points. Stafford loans issued today under the plan would have an interest rate of 4.3%, lower than the current interest rate for unsubsidized student loans but also higher than the current 3.4% interest rate for subsidized loans, where the government pays interest when a student is enrolled in school. The Obama plan links rates to Ten-year Treasuries but with no cap. Rates will rise with the market.

Senators Dick Durban (D-Ill.) and Jack Reed (D-RI) are proposing a variable interest rate, also tied to Ten-year Treasuries, through S 909, the Responsible Student Loan Act unveiled last week. It is similar to the Republican proposal. The rate is synched with 91-day Treasuries yet is capped at 6.8%.

"Our immediate attention should be on defusing the July 1 trigger that would double the interest rate on subsidized Stafford loans," Reed said. "Once that hurdle is cleared, this legislation – a long term solution to reducing student debt – must be front and center. Last month Rep. Joe Courtney (D-Conn.) introduced a House bill, HR 1595, that would postpone the rate hike for two years.

Also see: Rural Areas Give Incentives to those with Student Loan Debt

The Warren proposal syncs student loan rates to the Fed funds rate, currently about 0.75%, on subsidized Stafford loans. In their Brookings Institute blog of last Thursday, Beth Akers and Matt Chingos gave Warren's bill, S 897, short shrift. "Sen. Warren's proposal should be quickly dismissed as a cheap political gimmick," they wrote. "It proposes only a one-year change to the rate on one kind of federal student loan, confuses market interest rates on long-term loans -- such as the 10-year Treasury rate--with the Federal Reserve's Discount Window and does not reflect the administrative costs and default risk that increase the costs of the federal student loan program."

Also see: Student Debt Diary: Wait, What was the ROI on my Education?

While a spokesperson for Warren could not be reached for comment, Warren told CNN's Jake Tapper last week that the 2008 financial crisis was evidence that banks themselves are capable of high-risk behavior. If 0.75% was good enough for them, she seemed to be saying, it's good enough for the nation's college students. The gap between the Fed funds and student loans rate was also noted by Senator Reed when the Responsible Student Loan Act was announced. "There is something glaringly unjust," he said, "when Wall Street banks whose reckless behavior nearly brought this country's financial system to ruin can access 'easy' or 'cheap' money while students and families have to pay steep interest rates in order to pursue the American Dream."

Akers and Chingos prefer a compromise that "takes the market-based proposal of both President Obama and the House Republicans, the fixed-rate proposal of the President, and the interest rate cap of the House Republicans and Senate Democrats." Then the devil will be in the details. How much would be added to market interest rates to finance the administrative costs and default risk of the federal student loan program, for example, remains to be seen.

Regardless of how the problem is attacked, Mark Kantrowitz, senior vice president and publisher at Edvisors Network, seems to think the cost of education has nowhere to go but up, even if interest on Stafford loans stay the same. "The main benefits of a one-year extension to the 3.4% interest rate are that it gives Congress more time to think about interest rates and it delays the student loans issue until 2014, when it can become a campaign issue," Kantrowitz said. "But it doesn't make college more affordable."

He also observed that government support has been decreasing on a constant dollar per-student basis for four decades. This shifts more and more of the burden on to the families. Since family income has been flat, this leads to increased debt. Enrollment, he said, will shift from higher-cost colleges to lower-cost colleges as lower-income students are being priced out of a college education.

These dueling interest rate options could crash and burn by the July 1 deadline. If there is no compromise and the loan rate almost doubles, Republicans in Congress may cut their losses and move on, especially since students won't feel the impact of the rate hike this July. They will likely feel it a year later, however, in the run-up to the 2014 election, when the same can that Rep. Kline referred to could be sitting in the road.

Also see: Big Banks Looking to Catch a Break on Student Loan Debt

--Written by John Sandman for MainStreet

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