How the PROSPER Act Stacks Up for Student Debt: ONE Loan Proposal Would Increase Cost of Federal Loans and Increase Risks of Private Loan Borrowing

This blog post is one in a series that explores how the House proposal to overhaul the Higher Education Act would impact student debt. This bill, the PROSPER Act, was passed out of the Committee on Education and the Workforce in December 2017. Here we focus on certain elements of the PROSPER Act’s federal ONE Loan program, as well as the PROSPER Act’s potential impact on private loan borrowing; stay tuned for a deeper dive into its proposed changes to repayment options, as well as additional student debt-related topics.

There is widespread agreement that the current federal student loan program is too complex, resulting in a system that is difficult for students to understand and successfully navigate. The PROSPER Act rightly recognizes the need to simplify federal student loans, but the federal ONE Loan program it creates includes terms that would make federal loans costlier for students while also increasing the already high risks of private loan borrowing.

The PROSPER Act’s elimination of subsidized loans would raise borrowing costs for most borrowers.

Under current law, undergraduates currently receive subsidized loans, unsubsidized loans, or both. Subsidized student loans are allocated on a sliding scale based on financial need and carry valuable benefits: namely, no interest accrual while students are in school, for six months after they leave school, during active-duty military service, and for up to three years of unemployment or other economic hardship.

The PROSPER Act would replace existing loans with a new ONE Loan program that provides only unsubsidized loans.  With three-quarters (67%) of undergraduate Stafford loan borrowers taking out both subsidized loans and unsubsidized loans, it is worth considering whether student loan subsidies could be better designed to have a greater impact on college affordability. However, the PROSPER Act simply eliminates this valuable loan subsidy for undergraduates with financial need without investing the $27 billion dollars saved back into students. This would increase the cost of student loans by thousands of dollars over their lifetimes for many of the six million undergraduates who receive those loans each year. To just disappear this substantial investment in reducing the burden of federal loans is a major blow to student borrowers and college affordability.

TICAS has proposed streamlining the loan program into a new loan – also called a One Loan – that would carry a lower, but nonzero, interest rate for all borrowers on all of their loans while they are enrolled in school. To help students in repayment, our proposal includes interest-free deferments for Pell Grant recipients during periods of unemployment and economic hardship. Borrowers who received Pell Grants, by definition, have significant financial need, and are therefore much less likely to have family members who can support them during periods of unemployment or low earnings. Pell Grant recipients would be eligible for interest-free deferments on all their loans, rather than just their subsidized loans as is this case today, better targeting this benefit to those who need it most, when they need it.

Our proposed One Loan for undergraduates would also have:

  • A fixed interest rate that reflects the government’s cost of borrowing to provide predictability to students and ensure that the rates for new loans are in step with the economy.
  • A lower interest rate (reflecting only the government’s cost of borrowing) while borrowers are in school to increase affordability and encourage students to stay enrolled and complete, knowing that their interest rate will rise (to the government’s cost of borrowing plus a fixed margin) when they leave school.
  • An overall interest rate cap to ensure that interest rates on student loans will never be too high.
  • An interest rate guarantee to assure borrowers that their rate in repayment will never be too much higher than the rate on new student loans.

The table below summarizes selected features of federal (non consolidation) student loans for undergraduates under current law, the PROSPER Act’s ONE Loan proposal, and TICAS’ One Loan proposal.

Current Law
(New loans in 2018-19)

PROSPER Act
ONE Loan

TICAS
One Loan

Number of Loan Types

Two

One

One

Interest Benefits for Low-Income Students

Access to subsidized loans for borrowers with financial need

None

Interest-free deferments for Pell Grant recipients during periods of unemployment and economic hardship

Interest Rate

Fixed rates for new loans are set each year based on the 10-year Treasury note plus a set add-on of 2.05 percentage points, with an overall interest rate cap of 8.25%. Although rates for new loans are set each year, rates are fixed for the life of the loan.

Same as current law

Fixed rates for new loans would be set each year based on a U.S. Government-issued security (e.g., the 10-year Treasury note or 90-day Treasury bill), plus an additional fixed margin to reflect the cost of the student loan program. However, borrowers who are still in-school would have a lower interest rate that only reflects the government's cost of borrowing (i.e., that does not include the add-on).

Loan Limits

For dependent undergraduates:

  • $5,500 in the first year, $6,500 in the second year, and $7,500 in the third year and beyond
  • $31,000 total

For independent undergraduates and dependent students whose parents don't qualify for a parent loan:

  • $9,500 in the first year, $10,500 in the second year, and $12,500 in the third year and beyond
  • $57,500 total

Colleges have ability to deny or reduce loan eligibility on a case-by-case basis for individual students.

For dependent undergraduates:

  • $7,500 in the first year, $8,500 in the second year, and $9,500 in the third year and beyond
  • $39,000 total

For independent undergraduates and dependent students whose parents don't qualify for a parent loan:

  • $11,500 in the first year, $12,500 in the second year, and $14,500 in the third year and beyond
  • $60,250 total

Colleges have ability to deny or reduce loan eligibility for entire groups of students, based on certain characteristics or programs of study. Eligibility increases would be allowed on a case-by-case basis.

Same as current law

The PROSPER Act may lead to riskier private student loan borrowing

Most students borrow their loans directly from the U.S. Department of Education, but private loan volume has been increasing over recent years, to $11.6 billion in 2016-17. Private loans are one of the most dangerous ways to finance a college education. Experts agree that federal student loans should always be the first line of defense for students who need to borrow, because they have fixed interest rates, flexible repayment plans, and other important consumer protections that are not guaranteed by private loans.

The PROSPER Act removes important protections around “preferred lender lists” of private student loan options. Colleges can choose to provide those lists to point students toward private loan options that the college considers to have competitive or favorable terms. In the mid-2000s, Congress added additional protections after some college officials were found accepting lender payments to steer students to less favorable loans.

The PROSPER Act eliminates requirements for colleges to document why specific lenders are included in these lists, disclose to students information about any referral arrangements between schools and lender (arrangements that could include agreements providing material benefits to either or both parties), and to submit annual reports to the Department of Education outlining why these lenders are “beneficial to students.” Such changes would risk the creation of preferred lender agreements that benefit the institutions financially but are not the best terms available to students.

The current statutory requirements for preferred lender lists are critical oversight and consumer protections, and should be maintained. Additionally, Congress should take steps to help students better understand the risks of private loans and encourage students to exhaust their federal loan eligibility before considering private loans.

Ultimately, student-centered simplification of federal student loans demands changes that better support enrollment and completion, rather than simply eliminate or reduce the aid available.

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