Compromise reached on student loan interest rates

After a compromise was finally reached last week, a new student loan bill was sent to President Obama for signature.

Under the old federal student loan program, borrowers were offered a fixed rate. Under the new rate structure, which still drew opposition from nearly one-third of Senate Democrats when it passed last week, loans to undergraduates and graduate students, along with parents in the PLUS program, would be subject to a fixed rate plus the yield on the 10-year Treasury note.

Rates for loans taken out after July 1 of this year would be 3.9 percent for undergraduates, 5.4 percent for graduate students and 6.4 percent for those receiving PLUS loans. The rates are fixed over the life of the loan but would change for new borrowers each year.

In a compromise that pleased many Democrats who had initially been wary of using a rate that was subject to inflation and fluctuated with the markets, Congress set a cap on all loans: 8.25 percent for undergraduates, 9.5 for graduate students and 10.5 for PLUS recipients.

Perkins loan rates were unchanged.

* Interest is paid by the federal government during the in-school period.

Related:

• Student loans were the only kind of debt that grew during the latest recession (Cost of College)
• Federal student loan interest rates double to 6.8% (Cost of College)

Federal student loan interest rates double to 6.8%

Interest rates for federally subsidized college loans doubled to 6.8% on July 1, bringing “subsidized loans up to the same rate as unsubsidized ones for any new undergraduates seeking assistance financing college”.

…  In 2007, both types of loans had an equal interest rate of 6.8 percent, but a bill in Congress gradually reduced the subsidized rate, reaching 3.4 percent in 2011. Its aim was to make college more affordable and was to last until 2013, but the reduced rates were ended for budgetary reasons and the law’s expiration was moved to 2012. Last June, it was extended one year in a compromise after President Barack Obama encouraged Congress to keep the lower rates.

Here are the updated interest rates, with yesterday’s change highlighted in red.

* Interest is paid by the federal government during the in-school period.

Congress failed to reach a compromise before recessing last week.

… The Obama administration and Congressional Republicans supported a long-term change to how interest rates are determined for all federal student loans. Those plans differed in the particulars, but both would have tied interest rates to market rates, allowing them to rise without a cap as interest rates go up in the broader economy. Congressional Democrats pushed for a one- or two-year extension of the current 3.4 percent interest rate for subsidized student loans, arguing that the issue should be settled when Congress debates broader higher education legislation in the coming years.

According to a basic economic principle, when you subsidize something, you get more of it.

Student debt in the United States currently totals more than $1 trillion. College costs have soared,increasing 7.45 percent per year from 1978 to 2011 – a rate that exceeds both inflation and family income growth. The high level of debt and rate of default damages the economy by limiting other types of borrowing and delaying marriage and homebuying.

Related:  Why the extra Stafford loan subsidy should expire as originally planned (Cost of College)

Does the government make a profit on student loans? It’s complicated

The question of whether the federal government profits from student loans has come up recently in discussions about the various proposals to prevent the scheduled Stafford subsidized loan rates from doubling to 6.8% on July 1.  This question puzzled me when I wrote about it last November.  At that time I found conflicting accounts, which frankly made my brain hurt.  Since I was left with a lingering curiosity about these illusive profits, the recent discussions on the topic caught my attention.

On May 16  the Huffington Post reported of projected federal profits exceeding those of Exxon, Apple, and other corporate giants.

Figures made public Tuesday by the Congressional Budget Office show that the nonpartisan agency increased its 2013 fiscal year profit forecast for the Department of Education by 43 percent to $50.6 billion from its February estimate of $35.5 billion.…

The Education Department has generated nearly $120 billion in profit off student borrowers over the last five fiscal years, budget documents show, thanks to record relative interest rates on loans as well as the agency’s aggressive efforts to collect defaulted debt.

But that rate is set to double to 6.8 percent, the rate for unsubsidized loans (for richer students, or poor students with debt above the subsidized loan program’s limits), on July 1.

The Washington Post, in reporting on the political disagreements in Congress, referenced the DOE’s $51 billion projected profit.

Democrats … objected to increasing the rates within a program that generates vast income for the federal government. The Congressional Budget Office this week revised its figures this week, reporting that federal loans will generate almost $51 billion this year. Over the last five years, that sum is almost $120 billion.

“That $51 billion is more than Exxon,” Miller said.

“It’s time we stop using federal student loans as a profit center,” added Rep. John Tierney, D-Mass.

Writing for Yahoo Finance, Jason Delisle disputes this notion of student loan profits, pointing out that the high risk of default must be considered.

What about Senator Warren’s claim that the government makes money off loans to low-income students? Senator Warren is not telling the whole story here either. She points to figures that the non-partisan Congressional Budget Office says “do not provide a comprehensive measure of what federal credit programs actually cost the government and, by extension, taxpayers.” In fact, when the budget office “accounts more fully… for the cost of the risk the government takes on when issuing loans,” it reports that Subsidized Stafford loans – those made to low-income students – cost taxpayers $12 for every $100 lent out, or $3.5 billion per year….

The claim that the government makes money on these loans is even more dubious given that the Department of Education estimates that 23 percent of the Subsidized Stafford loans it makes this year will default. That puts it among the riskiest loan programs that the federal government runs. By comparison, about 7 percent of the loans under the Federal Housing Administration mortgage program are expected to default. That program provides loans to high-risk borrowers who do not qualify for a traditional mortgage because they lack the savings, income or credit history.

Finally, in the May 20 Washington Post WonkBlog Dylan Matthews concludes that the “federal government does not profit off student loans”, at least not “in some years”.

Matthews reiterates that the interest rates do not reflect market risk.

… they set the interest rate on student loans below the market rate. And because they’re below the market rate, that costs the federal government money. Contrary to popular belief, and many a breathless article, the government does not, in fact, book a profit on student loans. As New America’s Jason Delisle has explained, that’s because the Congressional Budget Office is required by law to use a bizarre and faulty method for determining the cost of government loans.

Matthews goes on to explain what is essentially an unresolved dispute on the profitability of government student loans.  Additional details complicate the picture.  For example, even according to the CBO’s “bizarre and faulty” calculations, some years with higher subsidies actually show a loss.

I suspect there’s no profit.

After reading all these explanations, the most definitive statement I will accept is that it appears the government does not make a profit on student loans, but it might depend on the level of subsidies for any given year.  As the headline says, it’s complicated.

Political outlook for the Pell Grant and other federal college aid

Next year the Pell Grant program will face a $5.7 billion shortfall and interest rates on federally subsidized students loans are scheduled to double to 6.8%.  Given the pressure to curtail overall government spending, it’s prudent to expect changes in federal college aid programs.

Sequestration  – The Pell Grant is protected from first-year cuts, but all federal student loan programs would be cut by 8.2% if no agreement is reached to avert the fiscal cliff.

Student loans  —  Several options have been discussed, including doing away with the subsidy but lowering interest rates by tying them to U.S. Treasuries.  For the purpose of targeting lower-income students, it has been argued that the recently enhanced income-based repayment program does a more effective job than loan subsidies.

Pell Grant  —  A push to overhaul Pell grants has come from various directions, with a common perspective that they need to become more efficient and effective.  Some ideas are to use the grants as an incentive for higher college completion rates and increased state aid for low-income students.

A fuller discussion of the issues can be found at What’s Next for the Pell Grant? (Inside Higher Ed).

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Does the government make a profit from student loans?

From What’s Next for the Pell Grant? (Inside Higher Ed), this caught my attention:

Even subsidized loans are a moneymaker for the federal government under the current accounting system, notes Sarah Flanagan, vice president for government relations and policy at the National Association of Independent Colleges and Universities.

But this is contested by a spokesperson for the Democrat-controlled Senate Committee on Health, Education, Pensions and Labor in a PolitiFact piece:

Subsidized loans do not make money for the government, Sessions said. They actually cost the federal government money.

An explanation of how student loans are a money-maker from This Can’t Be Happening:

Inflation, according to the government’s own statistics, is running at 2.7%. In other words, the government, which is the lender in the case of Stafford Loans, is already making 0.7% on its “subsidized” loans to undergraduates. And the inflation rate has been considerably lower in prior years, so the government has actually been making out like a bandit longer term. If it were to start earning 6.8% on these loans, like it’s already making on older loans, unsubsudized Stafford loans and Perkins Loans, the Treasury would be raking in huge profits on a loan program which is supposed to be helping make college affordable for lower income and middle-income students.

And this from the Minneapolis Star Tribune:

Now, the possibility that the federal government actually makes money on student loans may sound wildly improbable. Over the last several months we’ve heard repeatedly that keeping interest rates at the current level of 3.4 percent will “cost” the federal government $6 billion. Republicans want to pay for the reduced interest rates by trimming spending from health programs. Democrats want to go after tax breaks for businesses.

But the truth is that taxpayers do quite well by the student loan business. If you think about it just a little, it’s not hard to figure out why: The U.S. government pays almost nothing to borrow money that it lends out to college students at much higher interest rates. The current interest rate on a subsidized Stafford loan is 3.4 percent; on an unsubsidized Stafford loan the interest rate is 6.8 percent.

‘Shadow debt’ – unreported student loan borrowing

“Shadow debt” consisting of loans not captured in traditional reporting should be taken into account when the impact of rising college costs on families is considered.  A comment on CollegeConfidential explained it this way.

There’s several different ways to borrow for college which won’t show up with the current data mining techniques.
– Borrow from home’s equity
– Borrow against 401K
– Charge on credit cards
– Borrow from relatives

Given parent plus loans are fairly expensive (relative to this low rate environment) parents might be finding cheaper ways to borrow.

Interest rates on unsubsidized Stafford loans are 6.8% and Parent Plus loans are 7.9%.  By comparison, home equity rates averaged 4.58% this week.  Anecdotally, I can think of at least three families that have tapped into their home equity to help pay college tuition.  I borrowed from a relative when I was in college.

How much student debt goes unreported?

The question arises, then, of how much shadow student debt goes unreported.  Andrew Gillen did a back of the envelope calculation, based on Sallie Mae’s reporting of how families pay for college.  He concluded that the official student loan figures should be bumped up by about 31%.  I did a similar calculation and came up with a factor of 28%.

Official student debt figure has been reported to be more than $1 trillion.  Although it’s unclear whether it should be bumped up by 10%, 30%, or 100%, I’m convinced that a substantial amount of college debt is going unreported.

Related:

• Paying student loans in your 20s, 30s, and beyond interferes with saving for retirement (Cost of College)
• Federal student loan interest rate will stay at 3.4% for at least one more year (Cost of College)

Does increasing federal aid cause college costs to rise?

Some analysis and commentary on the idea that increasing federal aid causes college costs to rise

Cheap Student Loans Are Awesome and a No-Brainer (Ohhh Yeahhhh) (The Atlantic, Derek Thompson)

Even if student loans are a reasonable investment for government to make, it’s equally reasonable to wonder whether subsidizing college is responsible for higher college costs. As James Surowiecki has written eloquently, tuition is rising for reasons that have nothing to do with Stafford loans. But as Jordan Weissmann has written for us, the economic literature found that funneling money to middle class students has contributed to college costs rising even more than they would have without loans. The evidence is mixed.

Are we subsidizing student debt too generously? (Washington Post)

Yes, federal subsidies do drive up tuition. It’s Econ 101: basic economics dictates that conclusion.  —  Hans Bader, senior attorney and counsel for special projects at the Competitive Enterprise Institute

Why They Seem to Rise Together: Federal Aid and College Tuition (Minding The Campus)

Richard Vedder:

Andrew Gillen masterfully demonstrates that Bill Bennett is right–federal financial aid programs lead to higher tuition. The implications of this and related financial aid effects are profound:

1. The intended income transfers from taxpayers (and, increasingly bondholders) to students have been largely diverted to college coffers; swelling payrolls and leading to armies of new university bureaucrats, million-dollar college presidents, an academic arms race and other pathologies;

2. This, in turn, has thwarted university productivity growth and helps explain why higher education is vastly more expensive than in most other major developed countries;

3. The goal of helping low-income students has not been met, and a lower percent of recent college graduates come from less affluent students than was true in 1970 when Pell Grants did not exist;

4. To the extent that these aid programs have increased enrollments (read Gillen), they have added to the growing disconnect between labor-market realities and student job expectations, creating armies of college graduates who are bartenders, taxi drivers, etc.

5. Enrollment increases, in turn, have contributed to a dumbing down of higher education and to declining standards.

What to do? The federal government needs to wind down its financial aid commitment. Restrict eligibility for aid to truly low-income students. Impose performance criteria for aid recipients: mediocre students will lose aid. Make the college absorb some of the risk for loan defaults–a lesson we should have learned from the financial crisis. Give Pell Grants as vouchers directly to students, not schools. Reinstate private lending options. Unveil new human capital contract approaches that reduce debt reliance. Downsize and reinvent federal programs and allow market discipline to operate more.

All these recommendations are worth considering.

Related:

• Will a year of college cost $100,000 in 18 years? (Cost of College)
• Reasons for surging college costs, including ‘massive price discrimination’ (Cost of College)

Winners and losers in recent college student loan legislation

Recent legislation saves $7 billion for some college students but creates $20 billion in extra costs for others.

Last-minute legislation to keep the subsidized Stafford student loan interest rate at 3.4% for at least one more year is estimated to save students approximately $7 billion, but the cost of other less publicized changes will cost them “roughly $20 billion”.

College students are facing a roughly $20 billion increase in the cost of their federal loans, despite a much-heralded deal in Washington to contain the expense of higher education.

Starting Sunday, students hoping to earn the graduate degrees that have become mandatory for many white-collar jobs will become responsible for paying the interest on their federal loans while they are in school and immediately after they graduate. That means they’ll have to pay an extra $18 billion out of pocket over the next decade.

Meanwhile, the government will no longer cover the interest on undergraduate loans during the six months after students finish school. That’s expected to cost them more than $2 billion.

These changes have received little attention as lawmakers instead focus on preventing a spike in interest rates on federal student loans. They are the fallout of earlier political battles and compromises over broader issues such as the federal budget and the national debt ceiling….

Another recent change cut the Pell Grant maximum eligibility period from eight to six years.

Related:  A roundup of pending federal college financial aid changes

Federal student loan interest rate will stay at 3.4% for at least one more year

Subsidized Stafford student loan interest rate will stay at 3.4% for at least one more year.

Congress acted just under the wire Friday to save college students from paying more for student loans. The legislation—which will freeze interest rates on federally subsidized Stafford loans at 3.4 percent, avoiding a scheduled increase on July 1 to 6.8 percent—now heads to President Barack Obama for signature, the Associated Press reports.

Who will foot the bill?

Most of the money is expected to come from raising premiums for federal pension insurance. But students also will help foot the bill. Congress is looking to get $1.2 billion in savings from changing eligibility for student loans. It limits loan eligibility to 150 percent of a program’s time to degree — or six years for a bachelor’s degree and three years for an associate degree.

Who will benefit?

The move to stop interest rates from doubling is expected to affect 7.4 million students, saving each an average of $1,000 in extra financing fees.

_______________________

More student borrowers turn to subsidized Stafford loans than any other type of college loan. Roughly 9.3 million students signed up for one during the 2010-11 academic year, according to FinAid.org. The federal government pays the interest on these loans while students are in school. With other student loans—including unsubsidized Stafford loans—borrowers are responsible for all the interest.

* Interest is paid by the federal government during in-school period.

Students qualify for the subsidized Stafford loan based on financial need, which is determined in part by the cost of attending a school. More than a quarter of undergraduate students with family income of $100,000 or more received subsidized Stafford loans at colleges costing $30,000 or more in 2007-08, according to the latest data from FinAid.org.

Related:  Overview of student loan options

Why the extra Stafford loan subsidy should expire as originally planned

Both political parties want to extend indefinitely the “temporary” lower interest rate of federally subsidized Stafford loans, a move estimated to cost taxpayers $30 billion over five years.

The same President Obama who once pledged we were done “kicking the can” on tough decisions is pandering for the youth vote (on Jimmy Fallon, no less) by insisting we extend the largesse. Meanwhile, in a discouraging development, the same Mitt Romney who insists we have to slash spending and reverse course on Obama’s “government-centered society” quickly caved and joined Obama’s call to extend the break.

Politics is ugly to watch sometimes.

Frederick Hess makes some good points that bolster my view the government should let the extra subsidy expire.

The Stafford is a middle class entitlement. We’re not talking about Pell grants for poor students. We’re talking about whether students can get an even bigger subsidy on already-subsidized loans.

Everyone has an offset to “pay” for the extension. Newsflash: we’re borrowing a trillion bucks this year. None of this is paid for. Any cuts we find could trim that debt. We need all those cuts and to let the 3.4% rate expire.

We really need to stop suggesting that it’s okay renege on obligations when we decide we no longer like the terms of contracts we voluntarily signed. It’s been a meme the last few years, especially with Occupy Wall Street, and it makes it really hard to teach students to honor their obligations.

Related articles

• Should the Lower Interest Rate on Stafford Loans Be Extended? (usnews.com)
• Political battle looms over doubling of student loan interest rate to 6.8%

Political battle looms over doubling of student loan interest rate to 6.8%

President Obama begins an all-out push on Friday to get Congress to extend the low interest rate on federal student loans, White House officials said, an effort that is likely to become a heated battle along party lines. If Congress fails to act, the interest rate on the loans, which are taken out by nearly eight million students each year, will double on July 1, to 6.8 percent….

With student debt at a record high of $1 trillion, the effects of this change would be widespread.  The debate becomes about who should pay, the borrowers or the taxpayers?

The Congressional Budget Office has estimated that a one-year freeze on the interest rate for subsidized Stafford loans would cost $6 billion.

The history

The low interest rate stemmed from the 2007 College Cost Reduction and Access Act, which reduced interest rates on subsidized Stafford loans over the following four academic years — from 6.8 percent to the current 3.4 percent — with the proviso that the rates would revert to 6.8 percent this July…

A political trap for Republicans and a win-win situation for President Obama

The pre-planned doubling forces GOP politicians to either approve a Democratic measure that extends the low interest rates, or else face protest from millions of students and their middle-class parents.

Many GOP legislators dislike the subsidized interest rate because it inflates education costs while delivering a disguised subsidy to the Democrats’ political allies in the education industry.

The trap “kinda makes sense,” said Mark Kantrowitz, publisher of Finaid.org, a financial aid website.

“It’s a ‘Heads I win, tails you lose,’ scenario, where if President Obama succeeds in getting it extended a for a year he gets a victory for a key segment of the voters [and] if it gets blocked, he can blame his opponents for blocking it.”

“Either way he wins,“ Kantrowitz said.

Mr. Courtney said he was hopeful that some Republican support would be forthcoming as the political stakes became more apparent.

If higher loan subsidies are approved, the poorest students could come out losing.

Outside Congress, even some of the strongest student-aid advocates debate the question. While nearly everyone is in favor of the broad goal of college affordability, some experts point out that even 6.8 percent is lower than the rate on most private student loans. And they question whether it is worth risking cutbacks in the Pell program for low-income students, one possible consequence of using more federal money to keep interest rates low on the Stafford loans, which are in wide use by middle-income students.