[Note: The interest rate on subsidized federal Stafford loans for college students doubled on Monday, July 1, rising from 3.4 percent to 6.8 percent. It's still unclear whether Congress will allow the increase to stand before the new school year gets under way. Below is our earlier explainer on the topic.]
Congress is, as ever, facing a deadline. Rates on some student loans are set to double on July 1 if it doesn't act. How much does this matter, and to whom? Let's break it down.
What exactly is happening on July 1?
The interest rate charged on subsidized Stafford loans is doubling, from 3.4 percent to 6.8 percent.
Back up. What's a Stafford loan?
It's a kind of loan product the federal government offers to college and university students.
It comes in two flavors. Subsidized Stafford loans are only available to students with financial need (that is, students for whom the cost of attendance exceeds what their family can contribute), and the government pays student interest on the loans for as long as they're in school. They are also limited to $3,500 for freshman year, $4,500 for the next year, and $5,500 thereafter. A student can't receive more than $23,000 in subsidized loans in total.
Unsubsidized Stafford loans currently have an interest rate double that of subsidized loans (6.8 percent), aren't limited to low-income students, don't include the government-paid-interest perk, but do have caps on how much you can borrow. Those caps, for both subsidized and unsubsidized Staffords, are well-summarized in this table from the Department of Education:
As the table indicates, subsidized Stafford recipients can use unsubsidized Staffords to cover expenses above and beyond the cap on their subsidized loans. They're also available to grad students who, as of the debt ceiling compromise, can't receive subsidized Staffords.
Note also that the current rate on unsubsidized loans — 6.8 percent — is the same as the rate that takes effect for subsidized loans on July 1. So if nothing changes, subsidized Staffords will go from having half the interest rate of unsubsidized Staffords to having the same interest rate.
Are those the only loans the government offers?
No, that would be too simple. The other big category is PLUS loans, which are available for graduate and professional students and parents of undergraduates. Currently, the interest rate on those is 7.9 percent; there are no limits on how big the loan can be (the size is set by the school, which determines cost of attendance), and the only real prerequisite is a favorable credit condition. Recently, the credit requirements were tightened, which led to a sharp jump in rejection rates, from 28 percent to 38 percent in a single year. Historically black colleges and universities (HBCUs) were disproportionately affected, which prompted talk of lawsuits on the part of those institutions against the Department of Education.
There are also Perkins loans, which are awarded to undergraduate, graduate, and professional students that schools have identified as being in "exceptional need." You have to attend a participating school to be eligible, and the lender is the school, which uses federal money as well as payments on previous Perkins loans to pay for it. They have an interest rate of 5 percent. Critics like Andrew Gillen have noted that a number of schools with many Perkins borrowers don't have that many Pell Grant recipients — another program targeting needy students. That, they argue, suggests that Perkins loans are divvied up based on how powerful the institution in question is, not on the objective need of the students who are borrowing.
Last but not least are consolidation loans, or loans which let you bundle up other student loans you've taken out into one package. The interest rate is based on those of the loans being packaged, but is not to exceed 8.25 percent.
Break this down a bit. How important are each of these programs?
According to the latest CBO projections, 2013 will see $28 billion in subsidized Stafford loans, $59 billion in unsubsidized Stafford loans, and $19 billion in new PLUS loans originated. Other estimates suggest that $1 billion in new Perkins loans are generated each year.
So the majority — 55.1 percent — of new loans are unsubsidized Staffords, 26.2 percent are subsidized Stafford, 17.8 percent are PLUS loans and 0.9 percent are Perkins loans (you can see this in the chart above). We can thus expect the rate change to affect about a quarter of new loans going forward.
Okay, back to July 1. Why are rates doubling on a quarter of federal student loans?
Because Congress keeps pushing the deadline back. This all started in 2007, when Sen. Edward Kennedy (D-Mass.) and Rep. George Miller (R-Calif.) put together the College Cost Reduction and Access Act, which gradually reduced the subsidized rate from 6.8 percent to 3.4 percent over the course of four years, with 3.4 reached in 2011. But for budgetary reasons that had to sunset. Originally it was going to expire in 2013, which was moved to 2012 as part of a compromise with Republicans.
In 2012, both Mitt Romney and President Obama lobbied Congress to extend the low rates, which it did at the end of June. But they only extended them a year, so they're due to expire again in a couple weeks.
Which students will this affect?
One thing to be really clear on is that the rate change only affects new student loans, for undergraduates who'll be in school in the future. It won't affect the $1 trillion pile of student debt that's currently weighing on college graduates and dropouts throughout the country. That's not to say it's not important, but it really has nothing to do with people who are already out of college.
What is the House doing about it?
House Republicans, notably House Education and the Workforce Committee chair John Kline, has proposed the Smarter Solutions for Students Act, which would totally overhaul interest rates and peg them to the U.S. treasury rate.
Most dramatically, it would make interest rates on student loans variable rather than fixed. Currently, your 6.8 percent interest on an unsubsidized Stafford carries for the life of the loan. The GOP proposal would have interest rates vary from year to year. Stafford interest rates (both subsidized and unsubsidized) would be the 10-year Treasury interest rate plus 2.5 percentage points, and the PLUS loan at the Treasury rate plus 4.5 percentage points. But it would also cap interest rates at 8.5 percent for Staffords and 10.5 percent for PLUS.
That means that, this year, Staffords would be at 4.7 percent and PLUSes at 6.7 percent. If, as projected by the CBO, Treasury rates rise, then by 2018-2023 the Stafford and PLUS rates would be at 7.7 percent and 9.7 percent, respectively.
The CBO estimated the plan would reduce spending, and the deficit, by $3.7 billion over 10 years (though the CBO's methodology on student loans is a little debatable). The House passed the bill, but the White House threatened a veto.
What about the Senate?
Sens. Tom Coburn (R-OK), Richard Burr (R-NC) and Lamar Alexander (R-TN) offered a bill that pegs interest rates on both Staffords and PLUS loans to the 10-year Treasury rate plus 3 percentage points, and that it made those rates fixed rather than adjustable, like under current law but unlike under the House proposal. That would lower rates on all these loans to 4.72 percent for the coming school year. It includes no cap on rates, unlike the House bill, with the exception of a 8.25% cap on consolidation loans. It's modeled after a plan Jason Delisle at the New America Foundation released last year. The Senate voted the plan down, 40-57.
A Democratic plan, supported by Obama, to extend the 3.4 percent rate for two years got 51 votes and couldn't break a filibuster. Sen. Elizabeth Warren (D-Mass.) has somewhat confusingly proposed setting the rate at 0.75 percent for a year, to replicate the overnight penalty rate that the Federal Reserve charges banks for emergency loans.
Additionally, Sens. Jack Reed (D-R.I.) and Dick Durbin (D-Ill.), along with Reps. John Tierney (D-Mass.) and John Larson (D-Conn.), have proposed the Responsible Student Loans Solutions Act, which would tie the rate on programs to the three-month Treasury rate, which is considerably lower than the 10-year rate, plus an amount determined by the Secretary of Education to cover administrative expenses. Assuming 2 percent administrative costs, that puts you in the region of 2.5-3 percent this year. But like House Republicans, Reed and Durbin would make interest rates vary over the life of the loan. Subsidized Stafford rates are capped at 6.8 percent and unsubsidized Stafford and PLUS loans at 8.25 percent.
Unlike Republicans and Reed/Durbin, Obama wants to keep student loans fixed-rate rather than adjustable, and doesn't want a cap, and unlike Reed and Durbin, he wants to tie to the 10-year rate rather than the three-month rate. He'd set subsidized Stafford rate at the 10-year Treasury rate plus 0.93 percentage points, the unsubsidized Stafford rate at the 10-year rate plus 2.93 percentage points, and PLUS loans at the 10-year rate plus 3.93 percentage points.
The overall approach, then, is broadly similar to the Senate Republicans' bill. The only difference is that Obama has slightly higher interest rates for PLUS loans and slightly lower ones for subsidized Stafford loans.
Man, that's a lot of plans to remember. Can you sum it up for me?
Sure. Libby Nelson at Inside Higher Ed had a phenomenal table summing up all the plans, which I've expanded on below:
And here's what you'd pay in interest this year under the various plans. The proposals generally use the Treasury price at the last auction before June, so that's what I've used below. I also assumed 2 percentage points in administrative costs for the Reed/Durbin plan, as suggested by their press materials:
It's important to remember, however, that for variable rate plans, a loan issued this year with the rate shown in the chart could face significantly higher rates later on. For example, in a recent report the Congressional Research Service projected that interest rates would rise under the House GOP plan, as 10-year Treasuries creep upward in the next decade:
Fixed-rate loans issued after this year would, under plans that tie to the Treasury rate, have different interest rates as well. Here's the CRS on Obama's plan, for instance:
Each line represents a cohort taking out loans in a given year. Later years are above earlier years, reflecting rising interest rates for new loans.
I'm still confused. So, who's plan is the best for students?
It's hard to say. Democrats have been aggressive in arguing that the House GOP plan would really hurt students in the medium-term. Rep. Miller, who reduced the subsidized Stafford rate to 3.4 percent in the first place, commissioned a Congressional Research Service report that looked at the consequences of the House GOP plan for three types of borrowers: one who receives the maximum amount from subsidized Stafford loans, another who receives the maximum in both subsidized and unsubsidized Stafford loans, and another (a parent, in this case) who receives $50,000 in PLUS loans.
The CRS report looked at figures for students who take 4 years to graduate as well as those who take 5. The report found that the House required students to pay more in interest than either current law or a scenario in which the current subsidized Stafford rate is extended, as you can see in the above chart.
But the scenarios here are pretty much guaranteed to work against the House GOP plan. It increases the cost of PLUS, assuming interest rates creep up in the next years, and it increases the cost of subsidized Stafford. But the bill also effects a big reduction in the interest rate for unsubsidized Stafford loans as soon as it takes effect, which continues for several years thereafter. And remember, unsubsidized Stafford loans are the majority of the loans the federal government issues.
If your only concern is reducing interest rates for the most people, then unquestionably the best plan is Sens. Reed and Durbin's. 2.04 is much lower than anyone else is proposing going for interest rates, and even if the three-month interest rate creeps up considerably, their rates will still be very low. The Congressional Budget Office projects the three-month rate will be up to 4 percent by 2023. In that case, Reed and Durbin's rate would be about 6 percent - well below current unsubsidized Stafford and PLUS interest rates. They also allows old borrowers to refinance in the new low rates, a major plus for the millions carrying thousands each in student loan debt.
But maybe that shouldn't be the priority. There's a growing body of literature suggesting that government programs like generous student loan rates encourage colleges to hike tuition. That, in the long-run, makes college less affordable for everybody. Additionally, unsubsidized Stafford loans and PLUS loans are very poorly targeted aid. If you think, as many experts do, that student loan programs generally lose money for the government, then losing money making college cost less for upper-middle-class kids is a bit hard to defend. Reed and Durbin's plan, specifically, probably costs about $184 billion over ten years. That's a lot of money that could do a lot of things.
The biggest reason to not think of the interest rate as the be-all and end-all is that income-based repayment is coming. The Pay as You Earn program lets borrowers after 2007 pay back loans by paying 10 percent of their disposable income every month for 20 years, after which the remainder is forgiven (it's 10 years for people in public service careers). The program actually called "income-based repayment" (which, confusingly, has also become a catch-all term for this set of policies) does the same thing for older loans, only with 15 percent of disposable income payments, and forgiveness after 25 years (10 for public service). There's also income-contingent and income-sensitive repayment, which work similarly.
The forgiveness part of those policies, Jason Delisle explains, function as a cap on interest rates. If, after 20 or 25 years, you've only paid the equivalent of 2 percent of the interest on your loans, it doesn't matter - the rest is forgiven, and that's your effective maximum interest rate. For some in the nonprofit sector, particularly those who don't earn much in that ten year timespan, the interest rate cap could turn out to be negative. The student could end up paying less back than the principal of what she borrowed.
So income-based repayment could render interest rates literally irrelevant for many borrowers. There are some who want to change that. Delisle and Alex Holt have suggested, for instance, delaying forgiveness loans above a certain amount, to prevent over borrowing, and making it harder for high-income borrowers to get loans forgiven. Those are mild changes but would make the program cheaper on the margin. Rep. Tom Petri (R-Wisc.) has proposed eliminating forgiveness in favor of capping the amount of interest that a borrower must pay through income-based repayment, which would be a much more dramatic change.
All of which is to say that the question of whether or not the interest rate on subsidized Stafford loans should be allowed to go up is among the narrowest ones that Congress could possibly tackle on this subject. #DontDoubleMyRate is a great hashtag, but it hides the actually crucial questions that Congress has to tackle on student loans.
Update: The original version of this post stated that the Senate Republicans' plan had no rate caps; while that's true for new loans, it actually caps consolidated loan rates at 8.25%. We regret the error. The table breaking down plans has been updated accordingly.