Double Trouble

Double Trouble

Looking for a long-term solution to federal student loan interest rates

The roughly 9 million students who rely on subsidized federal loans will see interest rates double from 3.4 percent to 6.8 percent on loans borrowed after July 1. It’s just the latest chapter in the nearly 50-year saga of the federal government trying to determine the appropriate rate for these loans.

The Obama administration has urged Congress to extend the 3.4 percent rate for one year, but an extension would cost an estimated $3.9 billion. Students and parents trying to plan and pay for college face confusion and uncertainty.

“While we applaud the administration’s proposal to postpone the doubling of the Subsidized Stafford Loan interest rate, in the future we must find a permanent, sustainable solution to providing low-cost, predictable federal loans to students and parents,” says Justin Draeger, president of the National Association of Student Financial Aid Administrators.

A Brief History

Federal student loan interest rates have traditionally been predictable, but Congress changed them several times in recent years. Most changes have unfortunately been initiated by budget or politics.

Interest rates were fixed at 6 percent from 1965 to 1988 and at 10 percent from 1988 to 1992. In 1993, Congress switched to a variable rate tied to market interest rates. In 2002, Congress abandoned that rule and fixed the interest rate at 6.8 percent beginning in July 2006—a change welcomed by student aid advocates; at the time, 6.8 percent was seen as favorable. 

A provision in Democrats’ 2006 campaign platform pledged to make loans more affordable by cutting the interest rate in half. Democrats won control of both the House and Senate in the 2006 elections but were unable to follow through with their pledge. It would have cost more than $130 billion over 10 years to halve the rate on most federal loans.

Instead came the College Cost Reduction and Access Act, which temporarily phased in interest rate reductions only for subsidized federal student loans. Interest rates on subsidized Stafford loans decreased from 6 percent in 2008-09, to 5.6 percent in 2009-10, 4.5 percent in 2010-11, and 3.4 percent in 2011-12. To keep costs down, the bill set the rate to double to 6.8 percent for the 2011-12 award year.

No Easy Answer

Criticizing Congress for how it has set interest rates on student loans is easy. It’s equally challenging to develop an equitable system to provide low, predictable interest rates that don’t impose unsustainable costs for the federal government.

Fixed interest rates provide borrower predictability but can be inequitable and unsustainable for the government. Since market fluctuations impact rates, any fixed rate will become either too high or too low depending on the market.

Today, the interest rate on a 10-year Treasury note is less than 2 percent. This causes many to question why the federal government would charge 6.8 percent for subsidized student loans. A variable rate may be more sustainable and equitable, but it’s far less predictable for families.

Despite increasing pressure for Congress to extend the current interest rate, that prospect faces an uphill battle. Last year, Congress passed three budget bills that impacted student aid, and two of those bills trimmed government subsidies on student loans. Together, last year’s budget bills: eliminated the in-school loan interest subsidy for graduate and professional students; eliminated some Direct Stafford Loan repayment incentives; and temporarily suspended the interest subsidy during the six-month grace period for Direct Stafford Loans.

The federal budget is likely to continue to drive student aid policy. This year, Congress faces a sequestration provision that was included in the Budget Control Act of 2011. It will implement an across-the-board spending cut for most discretionary federal spending. Also, the Pell Grant program will again face funding shortfalls in the FY2014 federal budget.

All this suggests Congress will be preoccupied with budget savings and not spending on federal student loan subsidies. It also suggests Congress will be too preoccupied tackling short-term budget issues to develop a long-term solution for federal student loan interest rates.

Haley Chitty is director of communications for the National Association of Student Financial Aid Administrators.


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