What the $$$$ Just Happened to My Student Loans?!!

Paying for college is tough enough, but have you heard about the recent hikes in interest rates for student loans? Read on to find out how this affects you as either a current student or someone in repayment, plus how government officials plan to resolve the issue of crippling student debt.

As of yesterday, Stafford Loan interest rates doubled from 3.4% to 6.8%. Congress did not pass an alternative measure before the July 4th break, which will end at 2:00pm on Monday, July 8th. However, it still has the option to pass a measure that will retroactively affect the rise in interest rates, altering the Stafford Loan rates for this year’s students and perhaps others. This article will outline a few of the options Congress faces, what changes may be made, and how those changes might affect students with Stafford Loans.

Student Loans Crippling Many
Protestors advocate against increased interest rates.

What is a Stafford Loan and how does it work?

Stafford Loans are the most common kind of federal student loans available. They are available to students at accredited institutions

in the United States, a category to which most colleges and universities in the United States pertain. Stafford Loans can be either subsidized or unsubsidized. Of these, subsidized loans tend to have lower interest rates, and the federal government pays the interest that the loans accrue. Contrastingly, the interest that accumulates on unsubsidized Stafford Loans is capitalized, meaning that it is added to the part of the loan on which interest is paid.

Subsidized Stafford Loans are available to those who demonstrate financial need via the Free Application for Federal Student Aid (FAFSA) form, which must be renewed each year a student wishes to apply. Unsubsidized Stafford Loans are available to all students who meet the Stafford Loan requirements, which can be found here.

In addition to Stafford Loans, the government gives out PLUS Loans, which are unsubsidized loans and in the past have had higher interest rates than Stafford Loans. PLUS Loans are available to graduate students and parents of students.

The Option Proposed by President Obama:

President Obama proposed an option, named Pay As You Earn, which would tie the interest rates of student loans to those of the market, using ten-year Treasury Note interest rates as a benchmark. Subsidized Stafford Loans would have interest rates 0.93% above those of Treasury Notes, while unsubsidized loans and loans given to graduate students and parents would have rates 2.93% and 3.93% higher, respectively. The president’s proposed option would also cap monthly student payments at ten percent of their monthly income, and it would retire any student debt after it has been held for twenty years.

While this option could be beneficial to many, it also carries with it a serious downfall: according to the New York Times, Treasury Note rates have been known to go as high as 8 or 9 percent, and if this were to happen again, it could lead to incredibly high student interest rates. Moreover, Obama’s plan would only apply to Stafford Loans taken during or after 2011. Finally, the plan’s use of fixed interest rates could leave students paying very high rates if they attend school during times of economic success.

Senator Elizabeth Warren’s Plan:

Student Debt Cartoon
Student debt represents a serious economic issue.

Senator Elizabeth Warren, a Democrat from Massachusetts, proposed a plan that would provide students with the same interest rates as those given to large banks when borrowing from the Federal Reserve (currently 0.75 percent). Warren voiced that “the federal government is going to charge students interest rates that are nine times higher than the rates for the biggest banks – the same banks that destroyed millions of jobs and nearly broke this economy” (US News). But while Warren’s case may make sense at face value, it does not account for an important fact: banks are only given such low interest rates on very short-term loans, which are often paid back overnight. US News notes, “Even the U.S. government, the epitome of a trustworthy borrower, is paying around 1.8 percent in interest on its 10-year loans now, and nearly 3 percent on its 30-year loans.” Clearly, it doesn’t make economic sense to provide such drastically low interest rates to students when federal student loan default rates for borrowers are as high as they currently are (read more here).

However, while Warren’s plan would cost the government a sizable amount of money, it is only a year long, with its intended purpose being to provide Congress with more time to find an alternative solution to raising student interest rates.

Allow Interest Rates to Increase as Planned:

Consumer advocate Stef Gray explains the effects of increased interest rates for students: “Ultimately what this is going to mean for students is that they’re going to pay – given a typical ten year repayment plan – four thousand dollars more. That’s an increase of a thousand dollars per year in college, and I think the average student could use an extra thousand dollars in his or her pocket.” She also highlights the fact that “the federal government currently makes thirty-six cents on every dollar that students borrow,” relating this to last years $51 billion ‘profit,’ which she points out is larger than the profits of any Fortune 500 company.

But the federal government, says Dylan Matthews of the Washington Post, does not actually profit from student loans. In fact, “they actually lose money.” According to Matthews, this is because the government places “student loans below the market rate.” Why does this happen? Because the Congressional Budget Office, which is in charge of determining the cost of government loans, is required by law to use a method that “discounts all government loans using the returns on Treasuries of similar maturity.” Which is economist talk for having too much faith in students’ ability to pay back their loans, since Treasuries are far more reliable than student loans. Why does it look like the government is making money off of students? The method accounts for the higher returns that student loans give the government, but it does not factor in the default rates. In other words, it misses a key piece of information: the number of people that probably will not pay the government back.

Ultimately, the argument cannot be made that the government is trying to make money off of students by raising interest rates on Stafford Loans because the government’s methods make this impossible. It can be argued, however, that increasing interest rates will also increase the default rates on student loans.

What does this all boil down to?

According to CBS News Analyst Mellody Hobson, certain social effects that carry deep economic implications have historically accompanied increases in student debt. To name a few, people start families later, home ownership goes down, and investment in new businesses drops, all of which lead to a slower economy. Because of this, the money that the government loses when lowering interest rates could be seen as an investment in the economy. This could be particularly important for congressional officers to keep in mind given the competition between domestic and foreign workers for job positions.

If the government does not lower interest rates, students might be caught in a trap: On the one hand, students who pursue more education would be more qualified for jobs but subject to long-term debt that stifles their ability to participate in the economy. On the other hand, students who chose not to pursue higher education would not be subject to massive student debt, but they would be much less competitive in the job market. It would seem that lowering interest rates is not only in the students’ best interest, but also in that of the country.

Works Cited:

Ellis, Blake. “Student Loan Default Rates Jump.” Money.CNN.com. http://money.cnn.com/2012/09/28/pf/college/student-loan-defaults/index.html. (accessed July 1, 2013).

Gray, Stef. “Congress inaction to double student loan rates.” Youtube video, 6:35, posted by “RTAmerica,” June 21, 2013, http://www.youtube.com/watch?v=XfVp3RoD5F4.

Kurtzleben, Danielle. “What Elizabeth Warren Gets Wrong (And Right) About Student Loans.” USNews.com. http://www.usnews.com/news/articles/2013/05/09/what-elizabeth-warren-gets-wrong-and-right-about-student-loans. (accessed July 1, 2013).

Matthews, Dylan. “No the Federal Government Does Not Profit Off Student Loans (In Some Years – See Update).” WashingtonPost.com. http://www.washingtonpost.com/blogs/wonkblog/wp/2013/05/20/no-the-federal-government-does-not-profit-off-student-loans/. (accessed July 1, 2013).

StaffordLoan.com. “Am I Eligible for a Stafford Loan?” StaffordLoan.com. http://www.staffordloan.com/stafford-loan-info/faq/am-i-eligible-for-a-stafford-loan.php. (accessed July 1, 2013).

StaffordLoan.com. “Stafford Loan Frequently Asked Questions.” StaffordLoan.com. http://www.staffordloan.com/stafford-loan-info/faq/. (accessed July 1, 2013).

Watson, Bruce. “Obama’s Proposed Student Loan Debt Remedy Carries A Hidden Trap.” DailyFinance.com. www.dailyfinance.com/on/obama-student-loan-debt-remedy-interest-rate-trap/. (accessed July 1, 2013).

Weissmann, Jordan. “Here’s How Expensive Student Loans Could Be Under Obama’s New Plan.” TheAtlantic.com. http://www.theatlantic.com/business/archive/2013/04/heres-how-expensive-student-loans-could-be-under-obamas-new-plan/274879/. (accessed July 1, 2013).

Wikipedia, s.v. “Stafford Loan,” accessed July 1, 2013. http://en.wikipedia.org/wiki/Stafford_Loan#Interest_rates.