Student Loan Fairness Act: Can We Afford to Bring Down Student Loan Rates?

Current discussions within the House and Senate concerning changes to the interest rates charged on loans to college students provide an effective but painful illustration of the dysfunctionality of Congress. Posturing and pandering are taking precedence over a coherent discussion of the key issues involved. The likely income is Congress either punting a meaningful resolution down the road for two years, or a complex solution that creates uncertainty for debtors already struggling with repayment concerns.

Here’s the situation. Without congressional action on July 1 loans with interest rates already subsidized by the government will rise to 6.8% from 3.4%. Two-thirds of all loans have been made at unsubsidized rates, which have always been (and unless action is taken will remain at) 6.8%. Average student debt is also at an all-time high, $26,000 as estimated by the Project on Student Debt.

Both Republicans and Democrats want to drop current rates. They disagree on the type of the reduction and how long it would last. Some would allow the rates to move up with market changes, meaning that if and when inflation returns, rates could jump. The alternative plans almost seem as numerous as the number of people in Congress:

-Some Senate leaders want to extend the 3.4% rate for another two years while they rewrite the Higher Education Act that deals with federal financial aid programs.

-The first bill Senator Elizabeth Warren (D-Mass.) has introduced since her election would reduce student loan rates to 0.75%, equaling the Fed discount rate for banks. Warren probably has the most student friendly bill in that it offers the most dramatic rate reduction that she believes would help the economic expansion.

-Senator Kristen Gillibrand (D-N.Y.) wants to set a 4% cap and allow loan refinancing at that level.

-Last Thursday the House passed a bill to reset student lending rates yearly at 10-year Treasuries plus 2.5% for college students, and 4.5% for graduate students. The Congressional Budget Office estimates the loan rates to be 5% in 2014 and 7.7% in 2023. The House proposes capping these loans at 8.5%.

-In March, Democratic Rep. Karen Bass (D-Calif.) introduced the Student Loan Fairness Act, or what some term the Student Loan Forgiveness Act. Monthly loan repayments would be capped at 10% of discretionary income and would involve possible debt forgiveness.

-As for President Obama, his plan would also use 10-year Treasuries. His plan would lower the 3.4% rate for subsidized loans this year to about 1.6% (by my reading of the plan). Each year rates would be set at the Treasury plus 0.93 basis points for the life of the loan. In a higher-rate environment the borrower would be locked into a higher rate loan for the loan’s life.

Confused? This chart from Inside Higher Ed does as good a job as possible of summarizing the alternatives, but note that more alternatives appear to be offered daily.

Cutting through all of the alternatives, what is likely to happen in the near term? Given that politicians need votes, rates are unlikely to double. While the House says it will not sign up again for postponing the rate increase, they can certainly justify doing so in the context of the overall Higher Education Act. Don’t be surprised to see postponement of resolving this topic to the end of the year, if not beyond.

A long time ago when I had a student loan to repay, I repaid it, no whining, and no asking for a break. I signed a contract and fulfilled it. (I think the rate was 5.25% in a much higher-rate environment). As Senator Warren correctly points out, the world has now shifted to one in which big banks get bailed out and the senior execs of those banks feel little economic pain. So, many mortgage owners received a bailout. Now, again, we have students struggling with a disappointing job and in an economic hole from the day of graduation. All true, but are we continuing down a slope that the overall economy cannot sustain and that discourages the majority who meet their commitments?

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Charles Wendel

Wendel is the President of FIC Advisors, a management consulting firm that focuses on working with financial services companies to develop strategies in commercial banking and wealth management.

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