Pity the 18-year-olds and their parents who are trying to make sense of the student loan market as the May 1 deadline nears for choosing a college.
There are federal Stafford loans, subsidized and unsubsidized. There are federal PLUS loans for parents and graduate students. There are federal Perkins loans. There are private loans.
On Wednesday, President Obama proposed a major shift in the interest rate calculation for federal student loans: tying the rate to the government’s cost of borrowing, which is a variable benchmark. Currently loan rates are fixed by statute. Prospects for enactment of the Obama plan are uncertain. But Congress faces pressure to at least debate loan policy because the rate on a key type of loan will double — again, by statute — on July 1 unless lawmakers intervene.
Last year at about this time, a similar debate unfolded. The rate on the federal subsidized Stafford loan — described as subsidized because interest does not accrue on the loan while a student is in school — was scheduled to rise from 3.4 percent to 6.8 percent on July 1, 2012. Because it was a presidential campaign year, the loan issue got heavy publicity. Obama campaigned to freeze the rate. His Republican opponent, Mitt Romney, agreed. Congress extended the rate for one year.
Now the year is almost up, and there is a bipartisan push to rethink loan policy.
It’s worth giving an overview of the loan program before looking at policy questions.
Federal officials project that there will be about 10.7 million unique borrowers of federal loans in the 2013-14 academic year. They can borrow from one or more sources of funds.
●Stafford loans, named for a former Republican U.S. senator from Vermont, Robert Stafford, are a cornerstone of the federal loan program. Undergraduate students with demonstrated financial need — generally from low- to moderate-income families — are eligible for a subsidized Stafford loan. The government projects that about 7.2 million students in the coming academic year will take out such loans. No student may borrow more than $23,000, cumulatively, under this type of loan. The rate is for these loans is 3.4 percent until July 1. Then, absent any change in law, it will be 6.8 percent.
The total volume of subsidized Stafford loans for fiscal 2014 is estimated to be $29.3 billion.
●Unsubsidized Stafford loans, at a rate of 6.8 percent, are available to graduate and undergraduate students without a requirement to demonstrate financial need. Total annual volume of these loans is estimated at $62.7 billion a year. There are certain limits on this type of loan too.
●PLUS loans, available to graduate students and parents of dependent undergraduates, are issued at a rate of 7.9 percent. Total annual volume is projected at $20 billion. Curiously, the acronym means Parent Loan for Undergraduate Students. But obviously, that is a misnomer for PLUS borrowers who are graduate students.
●Perkins loans, named after Carl D. Perkins, a former Democratic U.S. representative from Kentucky, target undergraduate and graduate students with exceptional financial need. These federal loans , with a rate of 5 percent, are issued through participating schools. Funds for this program are limited. Not everyone who qualifies for a Perkins loan gets one. Total annual volume is projected at $857 million.
(Note: Consolidation loans are also available from the federal government for borrowers who want to combine various federal loans into one.)
●Private loans are available from various nonfederal sources at various rates. But experts caution that terms are not as favorable as those available through the federal government.
As the above demonstrates, the student loan market is much bigger than it sometimes seems to be in the debate over interest rates. Not every rate on every federal student loan is scheduled to double July 1. At issue, under the law, is the rate on the subsidized Stafford loan for new borrowers.
Doubling the rate would add, experts say, about $1,000 to the cost of a given loan. But the effect of that for a 10-year loan, considered another way, would amount to less than $10 a month on a typical repayment bill.
Obama’s budget also puts into play potential changes for various types of loans.
Under his proposal, the rate for subsidized Stafford loans would be equal to the yield on the 10-year treasury note plus 0.93 percentage points. For unsubsidized Stafford loans and for Perkins loans, the rate would be the 10-year T-bill rate plus 2.93 percentage points. For PLUS loans, the rate would be the 10-year T-bill rate plus 3.93 percentage points. The rates, Obama officials say, would be determined annually before the start of the academic year and then fixed for the duration of the loan.
In the short term, with market rates low, the Obama proposal would be good news for borrowers. The 10-year T-bill yield is now about 1.8 percent. So rates would go down for Stafford and PLUS loans (and slightly for Perkins loans).
But interest rates are projected to rise at some point. And the proposal provides for no caps. That means student borrowers in the future might well have higher rates, a point that led to criticism from some student advocates.
The Obama plan, said Ethan Senack of the U.S. Public Interest Research Group, “lowers interest rates over the next couple years, but it pays for that by charging higher interest rates down the road. It’s like robbing Peter’s little brother to pay Peter.”
The Obama administration, sensitive to this charge, said that any rise in interest rates would be cushioned by an initiative called “pay as you earn,” limiting loan repayment obligations to 10 percent of a borrower’s discretionary income. Obama officials say their plan aims to protect borrowers, put the loan program in sync with financial markets, and remain budget-neutral over the next decade.
Jason Delisle, an analyst with the New America Foundation, said the Obama plan is the “most practical way” to lower rates in the near term without busting the federal budget.
“If you wanted to make rates low all the time, forever, you’re talking hundreds of billions of dollars in new costs. That’s not really an option that’s on the table for anybody.”