Federal Government Default Could Increase the Cost of College for Millions of Americans

As the possibility of Congress failing to raise the debt limit and the federal government defaulting on its obligations becomes more real, we looked at what impact this might have on federal student loans.

Since the U.S. government has never defaulted before, we cannot know for sure what impact it would have. However, when the government came close to defaulting in 2011, J.P. Morgan issued a report entitled “The Domino Effect of a US Treasury Technical Default.” It concludes that “any delay in making a coupon or principal payment by the Treasury — even for a very short period of time — would almost certainly have large systemic effects with long-term adverse consequences for Treasury finances and the US economy.” The report estimates that a default would likely lead to a 20 percent decline in foreign demand for Treasuries over a one-year period, increasing the yields on 10-year Treasury notes by 50 basis points.

Enacted in August, the Bipartisan Student Loan Certainty Act of 2013 ties federal student loan interest rates to the 10-year Treasury note yield (as of the May auction) plus a fixed increment. So how much would a 50 basis point increase in Treasury yields cost college students and their families in higher interest payments on their student loans?

For a college freshman who starts school in fall 2014, takes out the annual maximum in subsidized and unsubsidized Stafford loans, and graduates in four years, it will increase the cost of college by about $1,000. That’s a 10% increase in interest payments over 10 years on the $27,000 she borrowed. If the government’s defaulting were to increase rates by 100 basis points, it would increase this student’s costs by $2,000 — a 20% increase in interest payments. For a graduate student who starts a two-year program next year, borrows the annual maximum in unsubsidized Stafford loans, and finishes in 2016, a 50 basis point increase would cost him about $5,000 more and a 100 basis point increase would cost him about $10,000 more in interest payments over a 25-year repayment period. (See the tables below for more details.)

In addition, J.P. Morgan and others expect that a default would slow economic growth, lowering family incomes and making it even harder for those already struggling to pay for college.

Undergraduate borrower taking out annual maximum subsidized and unsubsidized Stafford loan amounts, starting college in        2014-15 and graduating in four years

Scenario Amount entering repayment  Total payments over 10 overs Total interest paid over 10 years
Based on current CBO FY projections for 10-Yr T-Note yields  $28,100  $37,150  $10,150
       
If 10-Yr T-Note yields increase by 50 BPs  $28,200  $38,150  $11,150
 Difference from current projections ($)  $100  $1,000  $1,000
 Difference from current projections (%)  0%  3%  10%
       
If 10-Yr T-Note yields increase by 100 BPs  $28,300  $39,150  $12,150
  Difference from current projections ($)  $200  $2,000  $2,000
  Difference from current projections (%)  1%  5%  20%

 

Graduate borrower taking out annual maximum unsubsidized Stafford loan amounts, starting college in 2014-15 and graduating in two years

Scenario Amount entering repayment Total payments over 25 overs Total interest paid over 25 years
Based on current CBO FY projections for 10-Yr T-Note yields  $45,100  $91,100  $50,100
       
If 10-Yr T-Note yields increase by 50 BPs  $45,450  $96,050  $55,050
 Difference from current projections ($)  $350  $4,950  $4,950
 Difference from current projections (%)  1% 5%  10%
       
If 10-Yr T-Note yields increase by 100 BPs  $45,750  $101,150  $60,150
  Difference from current projections ($)  $650  $10,050  $10,050
  Difference from current projections (%)  1% 11%  20%

Calculations by TICAS based on February 2013 CBO fiscal year projections of 10-Year Treasury Note yields from "The Budget and Economic Outlook: Fiscal Years 2013-2023,” http://1.usa.gov/162YKgi. The dependent undergraduate student takes out a total of $27,000 in Stafford loans ($19,000 subsidized and $8,000 unsubsidized) and the graduate student takes out a total of $41,000 in unsubsidized Stafford loans. Figures in the table are rounded to the nearest $50 and 1%.Pauline Abernathy, Diane Cheng and Jessica Thompson

Posted in

| Tagged