The Growing Myth about Federal Student Loans
Policy + Politics

The Growing Myth about Federal Student Loans

iStockphoto/The Fiscal Times

Despite all the political hubbub and posturing over federal student loans, the benefits to students and their families would be relatively modest compared to the legislation’s substantial  price tag.  Only 3 percent of the roughly $1 trillion of overall outstanding student debt will carry the low interest rate extension this year.

President Obama won kudos on college campuses and from young voters earlier this year by vigorously pressing Congress to block the scheduled rate increase on highly subsidized Stafford loans from 3.4 percent to 6.8 percent. Since then, presumptive presidential nominee Mitt Romney and congressional Republican and Democratic leaders have all endorsed proposals for preserving the lower rate for an estimated 7 million students and their parents.

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However, the two parties have dickered over how to offset the roughly $6 billion it would cost to preserve the lower rate for another year, and are racing to hammer out a compromise before a weekend deadline. 

Few realize that the actual cost-benefit ratio of the legislation will be relatively low. That’s because the bargain basement 3.4 percent interest rate currently applies to only about a third of students holding or seeking subsidized federal loans. the borrower would save a maximum of $800 to $1,000 over the life of the loan, assuming he borrows the $5,500 maximum available to a third or fourth-year student. That works out to a savings of about $9 a month.  The interest savings would be even less for first-year students who could  borrow no more than $3,500 at the lower interest rate.

Senate Majority Leader Harry Reid, D-Nev., and Senate Republican Leader Mitch McConnell of Kentucky have taken charge of the negotiations and are  looking at a number of cost saving options, including one reportedly  favored by Reid that would revise pension payment contributions by employers and increase premiums paid by businesses for Pension Benefit Guaranty Corp. coverage.

Preserving the 3.4 percent interest rate for another year beginning July 1  would barely put a nick in the mushrooming student debt problem.  Under current law, only subsidized Stafford loans that were  issued to undergraduate students for the 2011-12 school year qualified for the 3.4 percent rate. All loans issued earlier carry higher rates. Those previously issued loans would not be affected by next week’s scheduled rate hike. The interest rate change would apply only to newly issued loans for the coming school year. Borrowers must  make monthly payments of at least $50 in repaying federal student loans, but they do not have to  begin paying the interest until after graduation.

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While the special low interest rate was designed to assist students from low and middle-income families, 12 percent of undergraduates who come from families earning $100,000 a year or more are also expected to qualify for these heavily subsidized college loans.

That’s because eligibility rules for subsidized loans take the cost of attending a college or university into account. This allows students from high-income families attending the most expensive educational institutions to qualify for the lower interest rate.  Conversely – and perversely -- students from families with lower incomes attending far less expensive community colleges and schools may not qualify for the 3.4 percent rate, and instead would have to pay the standard 6.8 percent rate.

Jason Delisle of the liberal-leaning New America Foundation said recently that the stakes involved in the battle over preserving the 3.4 percent interest rate are relatively small. He argues that Congress and the White House should focus more on developing less arbitrary interest rates for student loans and protecting the Pell Grant programs from cuts.

“We’ve got a student loan system where Congress has sort of layered on benefit after benefit and subsidy after subsidy . . . for people who are in fact struggling,” said Delisle, director of the Federal Education Budget Project. “It’s sort of bizarre to me when the president spends weeks touring the country talking about just the interest rate for one year on one subset of loans. It’s just sort of really weird.”