Rhetoric vs. Reality: The New Student Loan Rate Proposal

Updated 7/24/13: To the chagrin of some democrats, the proposed deal described below passed the Senate today with a vote of 81-18, and the House is expected to act on the bill by the close of next week.  Loan rates will be tied to the 10-year T-note.

A Senate committee announced this week that it had reached a compromise on student loan interest rates, and here’s (part of) what it says: Effective on passage, undergraduate interest rates will be “lowered from 6.8% to 3.85%” [note: newest language says 3.86%], graduate school interest rates will be “lowered from 6.8% to 5.4%”, and PLUS loans (which are available in addition to Stafford loans) will be “lowered from 7.9% to 6.4%”.

Why the doubt-inducing quotes?

Mostly in response to the overstated certainty, oft repeated in headlines like this or this,  that student loan interest rates are being, well, being lowered.

In the days ahead we’re going to hear that claim often (as well as equally extreme denunciations of it- more on that at the end), echoed by politicians on both sides of the aisle and from the White House.  And, to be sure, it is true. But only technically.  And only for the moment.

Let’s get right to it:

First the “technically” part-

This statement is probably most misleading in reference to undergraduate student loans.  Although the “official” rate for undergraduates has been 6.8% since 2006, the College Cost Reduction Act of 2007  steadily cut undergraduate interest rates to 6% (2008-9), 5.4% (2009-10), 4.5% (2010-11), and most recently 3.4% (2011-12).  So, to clarify, until July 1 of 2013, the official fixed interest rate was 3.4%, where it had been for year.  That decline was not just the government cutting students a sweetheart deal; it matched a similarly steep decline in the interest rate of three month treasury bills (you can do your own exploring here), which student interest rates were tagged to until 2006 and will be again any minute now.  Those 3 month T-Bill interest rates haven’t skyrocketed, so lowering the interest rate from its automatic increase to 6.8% a few days ago has actually been a foregone conclusion for weeks, and one of few truly bipartisan issues in Congress (every district has college kids, or parents of college kids, or people aspiring to be parents to college kids).

So why didn’t they change the rate sooner?  Some have called the delay a political tactic that allowed members of both parties to claim that the interest rate has “fallen,” even though it is technically higher now for undergraduates than it was three weeks ago.  Making the decision before the deadline would have had congressmen telling their constituents that rates had “only increased .4%,” which admittedly doesn’t have the same ring as “slashed by a whopping 2.95%!”  The latter really lends itself better to the exclamation mark.

For graduate students, who are a less potent political constituency, the story is a little different.  First of all, the College Cost Reduction Act didn’t affect the graduate student interest rate, which has sat at 6.8% since 2006, so 5.4% is by all accounts a decrease from the rate on loans issued over that period.

Two other big differences for graduate students: 1) Starting in 2012, subsidized deferment was not longer an option for grad students- that meant that, unlike undergraduates, who can defer interest until they graduate, graduate student loans start accruing interest almost immediately while their holders are still in school. 2) Graduate students can borrow more (the limit for grad students is $138,500 [$65,500 of which can be Stafford], compared to $35,500 for undergraduates [$23,000 of which can be Stafford]).  No surprise there; grad school tends to cost more, and grad students often study for more than 4 years, but this has some big implications where you’re talking about economies of scale.

And now that “just for the moment” part…

…and that’s the switch from a fixed rate to a variable rate.   In other words, student loans will switch to 3.45% and 5.4% if the legislation passes, but could rise shortly thereafter.  While caps have been proposed, (8.25%, 9.5%, and 10.5% for undergraduate, graduate student, and PLUS loans, respectively), a quick glance shows that all of these rates are significantly higher than the current rates- the undergraduate rate, for example, could more than double.

Some, including Elizabeth Warren, have compared the proposal to her arch nemeses, the credit card companies, likening the low “introductory rates” of students loans to a bait-and-switch.    Yet the argument at this extreme is a bit unconvincing as well.  First, the loans are still “locked-in” for the borrowers- if  you start a loan at 3.85%, that remains your rate for the life of that loan even if the rate for newly issued rises.  You can argue, as Warren has, that that’s like charging “current high sophomores to pay for current college sophomores” (because when the high school kids are in college their higher rates will subsidize the debt burden of the old college sophomores, in an attempt to ease the debt burden of the… you get it).  But lets remember that although the rate has been “fixed” for the past 8 years, it has changed *five times* during that stretch.  That’s not exactly stable, and not fair if we’re defining fair as equal interest rates regardless of context.

Additionally, Some economists argue that the old system (soon to be called the new system) of tagging student borrowing to treasury bills is more efficient because it better reflects the market and the potential of savings to contribute to repayment and more rapidly responds with lower rates in tough economic times (this historical chart shows how variable rates played out through the 90’s)- it’s worth noting that loans taken out before 2006 are now hovering around a 2% interest rate- it’s hard to beat that.  Republicans have suggested going a step further, slightly increasing interest rates in order to help repay the national debt- they claim they can get $715 million in the next decade (which seems like a lot, although, to contextualize it, that’s about 34% of the price of one B-2 bomber).  Others have expressed discomfort at the idea of the government “profiting,” as they characterize it, from student loans,  arguing a that the government has a public obligation to make higher education accessible.

It is important to note, as many have before me, that if we’re talking about an undergraduate who has borrowed $25,000 for college (remember, that’s the maximum Stafford, plus $2,000) and we’re thinking about a standard 120 month repayment, then the real differences we’re talking about here are small.  The shift from the 3.4% of a month ago to the 3.85% today comes out to a $5 difference per month; at the absolute high end, the cap of 8.25%, that moves up to $55 (about $30 for the average undergraduate borrowers), which is admittedly non-trivial if I’m remembering my first paycheck correctly, but most folks think it is unlikely that we’ll see them go anywhere near those levels without a major economic recovery.

For this reason, most commentators like Jason Delisle of the New America Foundation have been dismissive, saying that single digit percentage point shifts in interest rates are worth noting when considering a huge-ticket item like a mortgage, “but a home mortgage is $200,000, $300,000, $400,000. So moving the interest rate a little bit lower makes a big difference in your monthly payment. That’s not so on a $20,000 student loan.”  Noted.  Sort of.  But…

This tale of woe can be a bit more dismal for the graduate students, who, because of their different federal borrowing limits are more often referenced in particularly dire stories carried by the press recently- these are the students with $120,000 of debt (which, to Delisle’s point, can buy a decent starter home in most of rural America).  Some of these borrowers are professionals, with M.D.s. or J.D.s, or M.B.A.s that should make repayment a breeze (although that proposition is increasingly questionable with the latter two), but many are PhDs or M.A.s in non-lucrative fields (who the public increasingly seems less likely to feel sorry for) and M.A.- or certificate- seekers on non-traditional pathways scraping together classes at night, online, and at for-profits (who the public mostly just doesn’t think about.  Think “graduate student” and I’ll bet you’ll see a twenty-something at a research university library, but borrowing trends tell us otherwise).  For these students, let’s imagine a less extreme and not uncommon amount of graduate debt- $70,000.  That seems high, because the average grad student debt is around $30,000 for MA’s and $50,000 for PhD’s, but remember that those numbers vary a great deal between fields where aid and TA/RA positions are less frequently available.   With the shift from 6.8% to 5.4%, they’ll save about $49 a month (although a $756 monthly payment at the lower rate is nothing to sneeze at).   Should the rate increase to the max of 9.5%, that student with that debt would pay $905 per month- up $100 from the current 6.8% rate.

I’ve used the standard repayment option here, and there are others: extended repayment, income-contingent repayment, income-sensitive repayment, graduated-payment…. but if you’re getting overwhelmed already, so are most most borrowers, whose exit counseling typically consists of skimming a few webpages and multiple choice questions.

So let’s not overstate the enormity of the plan- whether you think it’s good or bad, it’s not a revolution- but let’s also avoid being so dismissive that we miss the individuals at the extremes.  For now, keep your eyes open for last minute tweaks and compromises (some democrats are pushing for a last ditch effort to lower the caps) and all of the tap dancing around language that will follow from both sides.

And, hey, not to make Senator Warren nervous, but if you happen to find yourself in the market for higher education at this particular moment, then you might want to lock in now.  These deals won’t be around for long.


Leave a Reply

Your email address will not be published. Required fields are marked *