If Congress does not act, interest rates on new subsidized Stafford loans will double from 3.4% to 6.8% on July 1, 2013. Previously originated subsidized Stafford loans and all other education loans will not be affected.
Doubling of the interest rates certainly sounds dramatic, but the actual impact on students will be more muted.
Each year, less than a third of undergraduate students receive federal subsidized Stafford loans. The average subsidized Stafford loan is $3,357, based on data from the 2007-08 National Postsecondary Student Aid Study (NPSAS), with average subsidized Stafford loan debt at graduation of $9,008 ($11,329 for Bachelor’s degree recipients). Only 3% of subsidized Stafford loan borrowers graduate with debt equal to the aggregate limit of $23,000.
Assuming a 10-year repayment term, doubling of the interest rate on $3,357 in debt increases the monthly loan payment by less than $7. On $9,008 in debt, the increase is less than $18; on $11,329 the increase is less than $24; and on $23,000 the increase is less than $48.
Doubling the interest rate does not double the monthly payment. Most of the monthly payment goes to principal, not interest. For example, on a 10-year term, increasing the interest rate from 3.4% to 6.8% increases the monthly payment by about one sixth (16.9%).
So while the interest rate increase will increase borrowing costs, it is not a major disaster.
Focusing on the interest rates, on the other hand, is a distraction from the real problem, which is the amount of debt, not the cost of debt. Grants have failed to keep pace with increases in college costs, shifting more of the burden of paying from college from the government to families. But since family income has been flat, there have been two main outcomes, especially among low and moderate income students. Student loans are the only form of financial aid with any degree of elasticity, so average debt at graduation increases every year. Students are also shifting enrollment to lower-cost colleges, such as from private non-profit colleges to public colleges and from 4-year colleges to 2-year colleges, causing a decline in Bachelor’s degree attainment.
Background on Interest Rates
To set the context, from October 1, 1992 to June 30, 2006, federal education loans had variable rates. Legislation enacted on February 8, 2002, scheduled a switch to a fixed 6.8% interest rate on both the subsidized and unsubsidized Stafford loans starting July 1, 2006. The College Cost Reduction and Access Act of 2007 implemented a phased-in interest rate reduction on the subsidized Stafford loan for undergraduate students only. This cut the interest rate from 6.8% to 3.4% over a four-year period: 6.0% in 2008-09, 5.6% in 2009-10, 4.5% in 2010-11 and 3.4% in 2011-12. New loans would have been at a fixed 6.8% interest rate starting July 1, 2012, in the middle of an election year. Congress passed a one-year extension to the 3.4% interest rate at a cost of $6 billion.
|History of Interest Rates (Repayment)|
|Year||Stafford Loan||PLUS Loan|
|10/1992 – 6/1994||91-day T-bill + 3.1%, 9.0% cap||CMT + 3.1%, 10.0% cap|
|7/1994 – 6/1995||91-day T-bill + 3.1%, 8.25% cap||CMT + 3.1%, 9.0% cap|
|7/1995 – 6/1998||91-day T-bill + 3.1%, 8.25% cap||CMT + 3.1%, 9.0% cap|
|7/1998 – 6/2006||91-day T-bill + 2.3%, 8.25% cap||91-day T-Bill + 3.1%, 9.0% cap|
|7/2006 – 6/2008||Sub 6.8%, Unsub 6.8%||7.9% (DL), 8.5% (FFEL)|
|7/2008 – 6/2009||Sub 6.0%, Unsub 6.8%||7.9% (DL), 8.5% (FFEL)|
|7/2009 – 6/2010||Sub 5.6%, Unsub 6.8%||7.9% (DL), 8.5% (FFEL)|
|7/2010 – 6/2011||Sub 4.5%, Unsub 6.8%||7.9% (DL)|
|7/2011 – 6/2012||Sub 3.4%, Unsub 6.8%||7.9% (DL)|
|7/2012 – 6/2013||Sub 3.4%, Unsub 6.8%||7.9% (DL)|
|7/2013 – TBD||Sub TBD, Unsub 6.8%||7.9% (DL)|
Once again the 3.4% interest rate is set to expire.
Many Proposals, Little Agreement
If Congress does not act, new subsidized Stafford loans made on or after July 1, 2013 will be at the 6.8% fixed rate. Old loans will not be affected.
Congress is less likely to act now, without the pressure of elections. Students were the swing vote in the presidential and several Congressional races last year.
If Congress does act, it is likely to be at the last minute, in yet another demonstration of brinksmanship.
There are two main options for Congressional action.
- One option is to delay the decision by passing another temporary extension to the 3.4% interest rate (or a lower rate). There are proposals for a 1, 2 or 4-year extension. The argument is that this will allow Congress to address the interest rates as part of a more comprehensive overhaul of the student loan programs during reauthorization of the Higher Education Act of 1965. But there is disagreement about how to pay for the cost of the extension.
- The other option is to enact a more “permanent” solution that pegs the interest rates to the 10-year Treasury rate in some fashion. These include proposals for a hybrid fixed/variable interest rate (each year’s loans have a new fixed rate that is pegged to the 10-year Treasury) and proposals for a variable interest rate.
|Interest Rate Proposals|
|Proposals||Subsidized Stafford||Unsubsidized Stafford||PLUS|
|President Obama||10-year Treasury + 0.93%, fixed, no cap||10-year Treasury + 2.93%, fixed, no cap||10-year Treasury + 3.93%, fixed, no cap|
|Sens. Coburn, Burr, Alexander (S.682)||10-year Treasury + 3.0%, fixed, no cap||10-year Treasury + 3.0%, fixed, no cap||10-year Treasury + 3.0%, fixed, no cap|
|Reps. Kline, Foxx (H.R. 1911)||10-year Treasury + 2.5%, variable, 8.5% cap||10-year Treasury + 2.5%, variable, 8.5% cap||10-year Treasury + 4.5%, variable, 10.5% cap|
|Sens. Reed, Durbin (S.909); Rep. Tierney (H.R. 1946)||91-day T-bill + TBD%, variable, 6.8% cap||91-day T-bill + TBD%, variable, 8.25% cap||91-day T-bill + TBD%, variable, 8.25% cap|
|Sen. Manchin III, Coburn, King Jr., Burr||Undergrad: 10-year Treasury + 2.5%,Grad: 10-year Treasury + 3.5%, fixed, no cap||Undergrad: 10-year Treasury + 2.5%,Grad: 10-year Treasury + 3.5%, fixed, no cap||10-year Treasury + 4.5%, fixed, no cap|
None of these proposals have the votes needed for passage in the Senate.
Borrowers should be wary of these proposals, as the cure may be worse than the disease. Some of the proposals do not include caps on the interest rates, raising the possibility of double-digit interest rates in just a few years. These proposals yield savings to the federal government, meaning that they ultimately will cost the borrowers more than a return to a fixed 6.8% interest rate. They are effectively interest rate increases masquerading as decreases.
There isn’t much that families can do to deal with a potential interest rate increase, other than reduce reliance on debt.
- Save as much as possible before college, since every dollar you save is about a dollar less you will need to borrow.
- Search for scholarships on free web sites like the Edvisors Scholarship Search and try to win scholarships through the ScholarshipPoints program.
- Be sure to claim the American Opportunity Tax Credit (if you qualify) when you file your federal income tax return.
- As an alternative to borrowing, consider tuition installment plans, which spread out the costs over 9 to 12 monthly installments for a small up-front fee and no interest.
- And finally, live like a student while you are in school, so you don’t have to live like a student after you graduate.
Mark Kantrowitz is a nationally-recognized expert on student financial aid, scholarships and student loans. He is Senior Vice President and Publisher of the Edvisors Network. His mission is to deliver practical information, advice and tools to students and their families so they can make informed decisions about planning and paying for college.
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