Interest Rates

Last year’s House Budget Resolution proposed charging students with financial need interest on their subsidized loans while they are still in school and using that money to reduce the deficit. In other words, the House Budget proposed increasing student debt to reduce government debt. Unfortunately, many expect that next week’s House and Senate Budget Resolutions will propose this change again, despite growing public concern about rising student debt and broad consensus on the importance of higher education and postsecondary training to the US economy.

Currently, undergraduates with financial need are eligible for subsidized Stafford loans, which do not accrue interest while students are enrolled at least half time or during the first six months after students leave school (the “grace period”). Eliminating this in-school and grace period subsidy (i.e., charging interest during these periods) would increase the cost of college by thousands of dollars for undergraduate students with financial need.

The charts below illustrate how much more a student would have to pay if the in-school and grace period interest subsidy were eliminated, assuming the student starts school in 2015-16, borrows the maximum subsidized student loan amount ($23,000), and graduates in five years.

Using current CBO interest rate projections, eliminating the in-school and grace period interest subsidy on subsidized Stafford loans would cause this student to enter repayment with $3,750 in additional debt due to accrued interest charges. As a result, she would end up repaying $4,900 (16%) more over 10 years and $6,900 (16%) more if she repaid over 25 years.

The added costs to students will be even higher when interest rates in the economy rise from their current levels, which are still historically low. If the undergraduate Stafford loan interest rate hits the statutory cap of 8.25%, eliminating the in-school and grace period interest subsidy on subsidized Stafford loans would cause this student to enter repayment with $5,700 in additional debt due to accrued interest charges. As a result, she would end up repaying $8,350 (25%) more over 10 years and $13,450 (25%) more if she repaid over 25 years.

At a time when higher education has never been more important or more difficult to afford, we should not be trying to balance the budget on the backs of students. We need to be doing more, not less, to keep college within reach for all Americans.

Note: More than four in five (82%) undergraduates with subsidized loans also have unsubsidized loans. If this student borrowed unsubsidized loans in addition to her subsidized loans and entered repayment with more than $30,000 in debt, she would qualify for a 25-year repayment plan

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On August 12, the Congressional Budget Office (CBO) released its estimates of the subsidy rates on federal student loans before and after enactment of the Bipartisan Student Loan Certainty Act of 2013 signed by President Obama earlier this month. These CBO estimates show:
  • That the government will profit from Stafford graduate, graduate PLUS, and parent PLUS loans in every year over the next decade, and beginning in 2016 will make even more profit from them than had been projected under prior law.  Note that CBO does not separate estimates for unsubsidized loans to undergraduate students versus graduate students, so the unsubsidized line understates the profits CBO is projecting from Stafford graduate loans.
  • That the government will still profit off of subsidized Stafford undergraduate loans for the next two years (but less so than if the rates had doubled to 6.8%), after which subsidized loans will require a subsidy that is equal to or greater than the subsidy under prior law.
Ultimately, these estimates underscore the increased profits projected from federal student loans under the new law as well as the shift in costs to students starting a few years from now, especially graduate students and parents of undergraduates.

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This week, the Senate passed legislation to change the way interest rates are set on federal student loans. It’s expected to pass the House next week and soon become law. While it would lower rates for borrowers this year, it is more of a missed opportunity than a cause for celebration, as we said in our statement last week. That’s because it is expected to cost students and families more over time than if Congress had done nothing at all after interest rates doubled on subsidized Stafford loans.

Over the next 10 years, the legislation is expected to cost borrowers $715 million more than if current rates were simply left in place, and current rates are already projected to generate $184 billion in profits for the government. It lowers rates for today’s students only by requiring future students to pay far more. Within a few years, new loans for undergraduates, graduate students, and parents are all projected to carry higher fixed rates than they do right now.

Still, the Senate-passed bill is better than the earlier bill passed by the House, which would have set truly variable rates – meaning the rates on existing loans would change every year while in repayment – and charged borrowers even more to pay for deficit reduction.

Several other proposals removed any cap on how high rates could rise, but Senate Democrats successfully fought to include caps in the final compromise. An amendment offered by Senators Reed and Warren would have lowered those caps to where interest rates are today: 6.8% for all Stafford loans and 7.9% for PLUS loans for parents and graduate students. Notably, that amendment got 46 votes, but not enough to prevail and prevent the final bill from passing with the higher caps.

As many in Congress have pointed out, the upcoming reauthorization of the Higher Education Act is a crucial opportunity to revisit student loan policy, including but not limited to interest rates, in the context of higher education reform as a whole. We urge Congress and the Administration to make college more affordable – not less – for both today’s students and tomorrow’s.

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With just three days until interest rates on subsidized Stafford loans are scheduled to double from 3.4% to 6.8%, Congress should not make college more expensive, either by letting rates permanently double or by making permanent changes that leave students worse off than doing nothing at all. Instead, Congress should freeze interest rates to avoid increasing the cost of college for millions of students and families already struggling to cover rising costs. The Reed/Hagan bill (S.1238) introduced today with more than 30 other senators would freeze rates for one year and pay for itself by closing a tax loophole. It’s scheduled for a Senate vote on July 10.

By contrast, the bill Senators Manchin, Burr, Coburn, Alexander, and King announced they will introduce today would be worse for students than doing nothing at all. It would let rates for subsidized Stafford loans more than double by 2018 and set no limit on how high rates on all new loans could rise.

There has always been a cap on federal student loan interest rates. As we, alongside other organizations that advocate for students and young people, recently wrote to Congress, a rate cap is essential to ensure that student loans remain affordable and that high interest rates don’t deter students from starting or completing college during periods of high and rising rates.

Nevertheless, some have objected to maintaining an interest rate cap, suggesting that the availability of income-driven repayment plans eliminates the need for any cap. But that’s simply not the case.

Still others have claimed that an interest rate cap isn’t necessary because federal consolidation loans would still have a maximum rate of 8.25%. However, the potential to consolidate is not a legitimate substitute for capping how high rates can rise. Consolidation comes with risks, which vary depending on the borrower’s specific circumstances. For example, consolidation can increase the total cost of the loan by lengthening the repayment period, and it can make it harder to qualify for Public Service Loan Forgiveness. We described these and other consolidation risks in our last post.

A recent alternative Democratic proposal would cap rates and keep subsidized loan rates below 6.8%, but rates on unsubsidized loans would be expected to exceed 7% by 2016. Because 82% of undergraduates with subsidized loans also have unsubsidized loans, keeping rates low on one while increasing rates on the other may not reduce costs for low- and moderate-income students, and could even increase them.

The table below compares how four recent long-term proposals compare to the current rates and scheduled rates for undergraduate subsidized Stafford loans over the next decade. Under three of the proposals, rates on subsidized loans would rise sharply—exceeding 7%, more than double the current rate, by 2018. The difference can be substantial. For a student borrowing the maximum allowable in subsidized and unsubsidized loans over four years, the difference in the rates can cost them over $5,000 more if they repay in 10 years, and over $7,000 more if they repay under an income-driven plan (for details, see our recent analysis here).

Projected Rates for Undergraduate Subsidized Stafford Loans

(based on CBO fiscal year projections for 10-year Treasury notes)

 

Years Rates Projected to  Exceed 7% (2013-2023)

Years Rates Projected to  Exceed 8% (2013-2023)

Cap on How High Rates Can Rise (Yes/No)

Scheduled Rate (6.8%)

NONE

NONE

Yes

Current Rate (3.4%)

NONE

NONE

Yes

Coburn/Burr/Alexander

2016-2023

2018-2023

No

Kline/Foxx

2013-2023*

NONE

Yes

Manchin/Burr

2018-2023

NONE

No

Alternative Dem

NONE

NONE

Yes

*Rate is projected to exceed 7% beginning in 2017 and would apply to all loans taken out after July 1, 2013, because under the Kline/Foxx bill, the rates for all loans vary each year throughout the life of the loans.
 

Both today’s students and tomorrow’s deserve affordable student loans, not so-called solutions that let rates double and rise even higher without any upper limit. Instead, current rates should be temporarily frozen so that Congress and the Administration have time to come up with a plan that makes real sense for both students and taxpayers and helps make college affordable for all. Both the Reed/Harkin bill, supported by a majority of the U.S. Senate and the Administration, and the new Reed/Hagan bill, do just that by extending current rates and fully covering the cost by closing unnecessary tax loopholes.

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With just nine days until interest rates on subsidized Stafford loans are scheduled to double from 3.4% to 6.8%, policymakers keep scrambling to come up with a long-term fix. But so far, their long-term proposals – actual and rumored – fall short on the most important measure of all: keeping loans affordable for students, both now and in the future.

The table below uses CBO projections for 10-Yr T-Note yields (fiscal year) to compare how three recent long-term proposals compare to the current rates and scheduled rates for undergraduate subsidized Stafford loans over the next decade. As you can see, rates would rise sharply under all three proposals, increasing the cost of college for millions of students and families already struggling to pay for college.

 

Projected Rates for Undergraduate Subsidized Stafford Loans (2013-2023)

 

Years Rates Projected to  Exceed 7% (2013-2023)

Years Rates Projected to  Exceed 8% (2013-2023)

Cap on How High Rates Can Rise (Yes/No)

Scheduled Rate (6.8%)

NEVER

NEVER

Yes

Current Rate (3.4%)

NEVER

NEVER

Yes

Coburn/Burr/Alexander

2016-2023

2018-2023

No

Kline/Foxx

2013-2023*

NEVER

Yes

Manchin/King/Coburn

2018-2023

NEVER

Uncertain**

*Rate is projected to exceed 7% beginning in 2017 and would apply to all loans taken out after July 1, 2013,  because under the Kline/Foxx bill, the rates for all loans vary each year throughout the life of the loans.
**Media reports on this proposal vary, and the proposal itself has not been made public.

The table shows that in five years or less, projected rates under these long-term proposals would exceed 7%, more than double the current rate. Some conservatives have objected to including any cap on how high rates can rise. Others have suggested that the availability of income-driven repayment plans eliminates the need for an interest rate cap. But that’s simply not the case.

Still others have claimed that an interest rate cap isn’t necessary because federal consolidation loans would still have a maximum rate of 8.25%. They argue that students who borrow when rates are even higher could consolidate into a new loan at 8.25%.

However, the potential to consolidate is not a legitimate substitute for capping how high rates can rise. Consolidation comes with risks, which vary depending on the borrower’s specific circumstances. Among the risks of consolidation:

  • Consolidation costs you more by extending your repayment period: the longer you stretch out your payments, the more interest you pay. Standard consolidation repayment periods range from 10-30 years depending on your debt level.
  • Any accrued but unpaid interest is capitalized (added to the loan principal) when you consolidate.
  • Rates on consolidation loans are rounded up to the nearest 1/8th of one percent of the weighted average of the loans or 8.25%, whichever is lower. This can also add to the cost of your loan.
  • Consolidating prevents you from paying down your highest interest loan first to reduce the average rate and total cost of your remaining debt.
  • The way repayment periods are automatically set in consolidation makes it harder to qualify for Public Service Loan Forgiveness (PSLF). The only payments that count towards the 120 required for PSLF are income-driven or “standard” 10-year payments. But “standard” consolidation repayment periods are longer than 10 years if you have at least $7,500 in debt.
  • If you consolidate a Parent PLUS loan with your own student loans, the resulting consolidation loan will not be eligible for Income Based Repayment or Pay As You Earn.
  • Benefits and rights associated with individual loans are lost in consolidation.

Both today’s students and tomorrow’s deserve affordable student loans, not so-called solutions that let rates double and rise even higher without any upper limit. Congress must not rush to make permanent changes that leave students worse off than doing nothing at all. Instead, current rates should be temporarily frozen so that Congress and the Administration have time to come up with a plan that makes real sense for both students and taxpayers. The Reed/Harkin bill, supported by a majority of the U.S. Senate and the Administration, does just that: extending current rates for two years while fully paying for itself by closing unnecessary tax loopholes.

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With interest rates on subsidized Stafford loans scheduled to double to 6.8% on July 1, today the House passed H.R. 1911 (sponsored by Representatives Kline and Foxx). It would permanently change the way interest rates are set and cost student borrowers more than letting rates double as planned. Meanwhile, the Senate is expected to vote soon on S. 953 (sponsored by Senators Reed and Harkin), which freezes current rates for two years. In addition, there are various other proposals, including one from the President.

To help track and compare these proposals, TICAS has developed a handy summary chart.

We’ve also analyzed how several proposals would affect students’ cost of borrowing, based on a traditional-age student who graduates in four years and borrows the maximum amount of subsidized and unsubsidized Stafford loans ($27,000). For each proposal, we compare the costs in a standard 10-year repayment plan and the income-based Pay As You Earn plan.

Here are some highlights from the full analysis:

Costs in the Standard 10-Year Repayment Plan

  • For a student who starts college this fall, the long-term change in the Kline-Foxx bill (H.R. 1911) would actually cost over $1,000 more than if Congress did nothing at all.

• Letting the subsidized loan rate double to 6.8% as scheduled would cost the student almost $4,000 more than leaving the current 3.4% rate in place.

• H.R. 1911 would cost the student over $5,000 more than leaving the current 3.4% rate in place.

  • For a student who starts college five years from now (in 2018), H.R. 1911 would cost the student over $1,800 more than if Congress did nothing and let rates double to 6.8%.

Costs in the Pay As You Earn Plan (income-based payments, 20-year repayment period)

Our findings underscore that interest rates do make a difference in what many students will have to pay even if they are in Pay As You Earn.

  • For a sample student in Pay As You Earn, extending the current 3.4% rate for subsidized loans saves the student a significant amount of money: ranging from almost $3,000 to almost $10,000 depending on the proposal.
  • Under H.R. 1911, this student would pay over $7,000 more in interest compared to an extension of the current rate, and over $2,000 more than if the rates were allowed to double.

Comprehensive reform is needed to keep federal loans affordable, support sensible borrowing, and provide well-targeted debt relief (note that our recent white paper includes such reform). However, with less than six weeks until student loan rates double to 6.8%, none of the current long-term proposals meet these goals. We must protect students now while giving Congress and the Administration time to consider and enact permanent changes that make sense for both students and taxpayers.

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Both the President’s FY14 Budget and the Comprehensive Student Loan Protection Act, reintroduced in the Senate this week, propose significant changes to federal student loan interest rates. Rather than being set by Congress, interest rates on new student loans would be tied to the U.S. Treasury’s 10-year borrowing rate that year and remain fixed for the life of the loan, even if interest rates dropped substantially. Though not identical in their details, both proposals would lower the interest rates for students and families who borrow this fall, but allow interest rates to rise steeply for those who borrow in the coming years. Based on CBO projections, interest rates for unsubsidized Stafford loans would exceed 6.8% by 2016 and rise above 8% by 2018.

Moreover, both proposals would eliminate the cap on student loan interest rates, which means that actual rates for all types of federal student loans could rise even higher than currently projected. For the first time ever, there would be no limit to how high rates could go. In addition to increasing the costs of loans and college, uncapped interest rates could deter students from enrolling in or completing college, particularly during periods of high and/or rising interest rates.

Some have suggested that an interest rate cap is not necessary if borrowers have access to an income-driven repayment plan, such as Income-Based Repayment (IBR) or Pay As You Earn (PAYE). In IBR, which is widely available, monthly payments are capped at 15% of discretionary income, and after 25 years of qualifying payments any remaining debt is discharged. In PAYE, currently only available to some current students and recent graduates, monthly payments are capped at 10% of discretionary income, and any remaining debt is discharged after 20 years. New borrowers in 2014 will have access to a similar repayment plan. The President’s budget goes a step further by providing access to existing as well as new borrowers starting in 2014. It also prevents the taxation of debt discharged through income-driven plans.

Although these programs can help keep monthly payments manageable, income-driven repayment plans are no substitute for a cap on interest rates.  First, under current law, not all federal loans or loan borrowers are eligible for an income-driven repayment plan. 

For example, to qualify for IBR or PAYE, borrowers must have a relatively high debt-to-income ratio. Second, even borrowers who qualify for IBR or PAYE can have to pay much more in total with higher-interest-rate loans. In income-driven repayment plans, the interest rate can affect both the monthly payment amount as well as the length of time in repayment. For example, a single borrower who enters repayment with $20,000 in debt and starts out making $30,000 a year (AGI increasing 4% a year) ends up paying much more in PAYE with a higher interest rate than a lower interest rate.

  • An interest rate of 6.8% rather than 3.4% would increase the borrower’s total cost by about $12,000.
  • An interest rate of 8.0% rather than 3.4% would increase the borrower’s total cost by about $19,000.

Comprehensive reform is needed to keep federal loans affordable over time, streamline the program, and better target benefits, but these recent proposals miss those marks. There is a better way forward. TICAS’ recent white paper proposes changes that keep loans affordable, simplify loans, and target benefits to those with more financial need. Our proposal includes both a universal interest rate cap and a guarantee that rates for borrowers in repayment will never be too much higher than the rates being offered to current students. As also detailed in our white paper, the benefits of the improved IBR plan should be targeted so that borrowers with very high incomes do not receive substantial forgiveness when they could well afford to pay more. Read our statement about the President’s FY14 Budget and our white paper on improving federal student aid to increase college access and success. 

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