Congress Should Act Today to Keep Student Loan Interest Rates Low
The interest rates on government-backed student loans are set to double if Congress does not act today. Currently, low- and middle-income students can take out federal loans—called Stafford Loans—at a rate of 3.4 percent. Today, under current law, this rate will increase to 6.8 percent—a rate that will make repayment on student debt much more difficult than it is already. PLUS loans, which are issued to parents and graduate students at a rate of 7.9 percent, will become more costly, as well. If Congress continues to stall, millions of college students will see their future loan obligations increase substantially, putting further strain on upcoming graduates who already face a bleak job market.
If this crisis sounds familiar, that’s because it is. Congress made the same deliberations last summer, and eventually extended the low interest rates for an additional year. This year, there is bipartisan agreement that a long-term solution—rather than yet another year-long extension—is needed. The question what long-term rate is appropriate for student debt is a complicated one—but allowing rates to double today would hurt both current and future students in an already ailing economy. Unemployment for young college graduates is close to 9 percent and underemployment is near 18 percent. What’s more, for recent graduates, wages increased 1.5 percent cumulatively between 1989 and 2012. For men, the increase was 4.8 percent, but women actually saw their real earnings decrease by 1.6 percent in this time period.
Three alternative proposals would tie federal student loan rates to market conditions. The House Republicans have passed the Smarter Solutions for Students Act, introduced by Representative John Kline (R-MN). The proposal ties student loans to the ten-year Treasury note, with an “add-on” of 2.5 percentage points for Stafford loans. PLUS loans would be offered at 4.5 percentage points above the T-note rate. President Obama has also proposed indexing student loans the ten-year Treasury, but with a much lower add-on. The president’s proposal would add only 0.93 percentage points for subsidized Stafford loans, and 2.93 percentage points for PLUS loans. A third proposal, introduced by Senator Elizabeth Warren, would tie student loans to the Federal Reserve discount rate for this year only, with the goal of allowing recent graduates to take advantage of low interest rates forecasted within the coming year. While Senator Warren’s proposal is a short-term solution, it offers the lowest rates proposed in Congress for students, and we hope such a solution would pave the way for a more sustainable long-term solution.
While all three proposals would let students benefit from low interest rates in the short run, each would expose students to different degrees of risk and future cost. Today, with the U.S. government able to borrow at historically low rates, federal loans do some students a disservice by saddling them with more debt than would private loans. But, interest rates are unlikely to remain low forever.
If Congress approved the House Republicans’ proposal, rather than simply extending the current 3.4 percent rate, students would only be better off if Treasury notes yield 0.9 percent or less—today, Treasury notes yields are 2.5 percent. Meanwhile, if Treasury note yields reached 4.3 percent (which, according to the Congressional Budget Office’s projections, will occur around 2016) students would be better off if Congress simply let rates double today!
The outcome of all three proposals and current law are concerning: rates on student loans will eventually rise, making repayment even more difficult than it is today. As our colleagues point out in their recent paper on young graduates, it is no secret that college has become increasingly expensive. Between the 1982-83 and the 2011-12 enrollment years, the inflation-adjusted cost for a four-year education at a private university, including tuition, fees, room and board, increased 130 percent. Median household income grew only 10.9% over that same period. The average household’s student-loan debt has nearly tripled since 1989, from $9,634 to $26,682 in 2010. Furthermore, because many recent graduates began college in the middle of the Great Recession, they were hit first by a poor job market (which reduced income and savings, affecting the financial support their families could provide) and second, by large cutbacks on state appropriations for higher education, which fell by 27.7 percent between the 2007-08 and 2012-13 enrollment years. The long-term solution thus lies not just in lowering interest rates for students, but also in stemming the rapid rise of tuition costs.
As noted above, the problem of debt is greatly exacerbated by the dismal labor market that recent graduates face. Additionally, research has shown that graduating during an economic downturn can lead to reduced earnings, greater earnings instability, and more frequent spells of unemployment over the next 10-15 years. This is clear when looking at the high underemployment rates for college graduates, who often take positions that do not require a college degree simply to earn some amount of income, or work as an unpaid intern for a period of time in the hope of garnering a paid position with the company in the future.
While it is expected to take a decade for the students who graduated during the Great Recession to achieve some semblance of economic stability, recent graduates must often begin repaying their loans within six months of graduation regardless of whether they have found a stable source of income. Many student loan policies include provisions to protect debtors who do not have resources to make payments—but the threshold is often set at an extreme degree of economic hardship, and is usually not available for more than three years. For those not in deferment or forbearance, default becomes a serious option: the Federal Reserve Board of New York found that 30 percent of student loans in the 4th quarter of 2012 were at least 90 days late on making payments.
Congress should take immediate action on student interest rates—not only for students who are currently in college but young people who are deciding whether a college education is within financial reach. Allowing interest rates to double does nothing to support young workers in an already troubled economy.