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

Once again, the country is facing the possibility of Congress failing to raise the debt limit and the federal government defaulting on its obligations. When we faced this situation in 2013, we blogged about the impact it might have on federal student loans, so we thought we’d look again now.

No one really knows for sure what impact the government defaulting 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 concluded 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.

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 2016, 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 2018, a 50 basis point increase would cost him about $5,000 more and a 100 basis point increase would cost him over $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.