Higher Education

Two weeks ago Ed Money Watch explained an alternative to the one-year extension of the 3.4 percent interest rate on newly-issued Subsidized Stafford loans for undergraduates pending in Congress. It would peg fixed rates on all new federal student loans to the 10-year Treasury rate plus 3.0 percentage points in the year the loans are issued. While the Congressional Budget Office says that extending the 3.4 percent interest rate on Subsidized Stafford loans by one year will cost $6 billion, this alternative proposal cuts spending by $52 billion. How have lawmakers and student aid advocates responded to this proposal? With deafening silence.

Policymakers and advocates think this proposal isn’t politically viable or beneficial for borrowers because it would set fixed rates on Subsidized Stafford loans issued this year at 4.75 percent for the upcoming school year (based on the rate today), which is higher than the current 3.4 percent that may be renewed. If any proposal sets the rate higher, some borrowers will pay more, they say. (The 10-year Treasury note proposal lowers rates for graduate students, too, but we will leave that aside for purposes of the discussion that follows.)

These skeptics obviously haven’t done the math. Nearly all undergraduates who borrow this year would owe less at graduation and pay less monthly under the proposed alternative—even those who are eligible for Subsidized Stafford loans at the 3.4 percent rate under the pending extension.

The table below compares how undergraduates who borrow the maximum amount of Subsidized and Unsubsidized Stafford loans in each year will fare under both interest rate proposals.

Here are a few key points on how the figures were calculated:

Regardless of financial need, all first-year, dependent undergraduates automatically qualify for $5,500 in Unsubsidized Stafford loans at a fixed interest rate of 6.8 percent. Within that limit, however, a borrower may qualify for up to a $3,500 Subsidized Stafford loan (which would carry the 3.4 percent interest rate) if he meets a needs analysis test. If a borrower qualifies for that maximum, then he has two loans: one loan of $3,500 at the 3.4 percent rate and another of $2,000 at the 6.8 percent rate within the $5,500 limit. The breakdown is a bit different for each year a borrower is enrolled, and many borrowers qualify for less than the $3,500 in Subsidized Stafford loans because eligibility is based on a sliding scale.

Additionally, under current law, Unsubsidized Stafford loans accrue interest annually while a borrower is in school. No interest accrues on Subsidized Stafford loans during that time. As a result, a student’s loan balance at graduation is not just the sum of their Subsidized and Unsubsidized Stafford loans, but the sum of their loans plus accrued interest. Thus, we calculate the weighted average interest rate for each year a student borrows based on the share of the student’s total loan balance at graduation that is Subsidized (3.4 percent interest) and Unsubsidized (6.8 percent interest).

In contrast, the 10-year Treasury note proposal Ed Money Watch discussed earlier would set the same fixed interest rate for both loan types. As a result, no weighted average annual interest rate applies.

Due to the higher interest rate on Unsubsidized Stafford loans under the pending one-year extension of the 3.4 percent interest rate for Subsidized Stafford loans, a borrower will actually graduate with a higher loan balance under the 3.4 percent rate proposal than under the 10-year Treasury note proposal. In fact, the higher rate of interest accrual skews the weighted average interest rate under the 3.4 percent rate proposal above 4.75 percent for first year students.

And even though second, third, and fourth year students will pay lower average interest rates on the loans they take out in each year under the 3.4 percent rate proposal, the higher interest rate on the Unsubsidized portion of their loans will result in higher loan balances. In the end, a student that borrows the maximum amount in all four years will actually pay less per month under the 10-year Treasury note proposal than under the 3.4 percent rate proposal.

To be fair, a very small share of students could end up paying a tiny bit more under the 10-year Treasury note proposal (a few dollars a month) for loans they take out this coming school year compared to the 3.4 percent interest rate proposal (e.g. students who borrow Subsidized Stafford loans but forgo the extra Unsubsidized Stafford loans for which they qualify). But many more borrowers—including graduate students—will benefit from the lower rate under the 10-year Treasury note proposal. Some critics will also point out that interest rates on future loans could be higher than 4.75 percent, even higher than 6.8 percent. That is true, but if the concern is that rates might go higher, then borrowers and policymakers may be better off just sticking with the current 6.8 percent.

Finally, some would-be supporters are nervous that President Obama and Democrats in Congress will accuse anyone who supports the 10-year Treasury note proposal instead of the 3.4 percent rate proposal of “raising interest rates on student loans.” If they do, point to this analysis. If they dismiss this analysis, then they are more interested in scoring political points than helping students.

Last Thursday, I participated in an event organized by the National Community Tax Coalition on expanding college access and completion that highlighted several approaches to connecting more low-income students with a college degree.

The interest rate on federal student loans has never garnered this much public attention. The president has been talking up his proposed one-year extension of the 3.4 percent interest rate on newly-issued Subsidized Stafford loans since his 2012 State of the Union address, and with bills to extend the 3.4 percent rate pending in Congress, every major newspaper has covered the issue. Regardless of whether Congress adopts a one-year extension of the lower interest rate, policymakers still need to rethink how interest rates on federal student loans are set.

The Asset Building News Week is a weekly Friday feature on The Ladder, the Asset Building Program blog, designed to help readers keep up with news and developments in the asset building field. This week's topics include housing, women in poverty, access to public assistance, banking, student loan debt and inequality.

Last Thursday, The White House hosted the first ever Summit on Financial Capability and Empowerment.  Did you hear all about it?  Probably not – it somehow slipped the evening news. 

These days, anyone who follows the news can recite statistics on student debt. The media has repeated countless times phrases like “there is $1 trillion in outstanding student debt” and “borrowers have an average of $23,300 in loans.” But do these numbers really mean what the media, policymakers and advocates think they mean? Which is, do these numbers tell how much debt the typical student carries? Not at all.

First and foremost, it’s important to clarify that “$1 trillion” refers to the total outstanding balance of the entire universe of student loans. That’s all loans from federal and private sources, for undergraduate or graduate students attending or who attended any type of school. The loans could have been taken out in September of 2011 for the current school year or they could have originated in 1995 but have not been repaid yet.

Similarly, that $23,300 number, which comes from a New York Federal Reserve Bank study of a representative sample of all outstanding loan balances as of 2011, refers to the average student loan balance only for students who took out loans. It excludes students who have already paid their loans off or who did not take out any loans.

Despite their ubiquity, these numbers don’t actually paint a picture of student borrowing as experienced by the typical borrower. Yet most press accounts imply that the average student loan balance for borrowers reflects the student loan balance for the average borrower.

In fact, most borrowers carry student loan balances well below the average. According to that same study, the median student loan balance is $12,800. This means that half of borrowers owe less than that amount and half owe more. Similarly, 75 percent of borrowers owe less than $28,000, and 90 percent owe less than $54,000 currently. While the press can certainly cite the average loan balance at $23,300, they should also make clear that most borrowers currently owe significantly less.

Now consider the discussion about debt owed by recent graduates. The most recent survey for the Baccalaureate and Beyond dataset, collected by the National Center on Education Statistics, provides data on cumulative student loan balances as of 2009 for the graduating class of 2008. These data show that the average student loan balance was $25,619 for students that took out loans.

But once again, the average borrower owed far less than that amount. Specifically, the data suggest that the typical borrower (the borrower with a loan balance at the 50^th percentile) owed $19,857 one year after graduation. Seventy-five percent of borrowers owed less than $33,857 and 90 percent owed less than $50,000. On the other end, 25 percent of borrowers owed less than $10,000.

It is also important to note that the Baccalaureate and Beyond data show that 65.6 percent of students took out loans. So that means that 34.4 percent of graduates of the class of 2008 had no loans to begin with.

This is why the distinction between average and median student debt, and the distribution of debt among percentiles of borrowers matters. By focusing on average student debt, journalists, policymakers and advocates are skewing the discussion on student debt toward one extreme that affects a minority of borrowers. They’ve convinced their audience (and likely themselves) that the average loan balance (which is disproportionately affected by outlier loans with particularly large balances) should drive the discussion, not the debt of the average student borrower, nor the debt levels of the majority of borrowers.

As the discussion on student debt continues, journalists, policymakers and advocates should bear in mind what the data cited above say about the typical borrower: she is in less debt than the average loan size figures would have us believe.

This blog post was originaly published on the National Community Tax Coalition's blog WorkForward.

The wrangling over the jump in student loan rates scheduled to take place on July 1^st has placed renewed focus on making college affordable. This is critical time to be having this conversation because the value of a college degree is only increasing in the post-recession economy, but, so is the cost of acquiring it.

While Congress has debated extending the 3.4 percent interest rate on Subsidized Stafford loans issued this year to undergraduates, advocacy groups are gearing up for a debate on longer-term reforms. They know the odds don’t favor Congress adopting a one-year extension of the lower rate again next year. Besides, spending $6 billion to save college graduates $9 a month isn’t a great deal for borrowers or taxpayers. So it’s good that student aid advocates want a better plan. But they aren’t off to a great start. They are gathering support for an outrageously expensive proposal that turns a blind eye to far more worthy aid, like Pell Grants.

The student loan interest rate proposal that is dominating discussions among advocates and other stakeholders would provide borrowers with variable interest rates that would be capped at the current fixed rates of 6.8 percent on Stafford loans and 7.9 percent on PLUS loans for parents and graduate students.

The rate on all newly-issued federal loans would be adjusted annually based on interest rates on short-term (three month) U.S. Treasury debt, plus a markup of two to three percentage points to partially offset costs. Today, that would translate into an interest rate of about 3 percent. If short-term U.S. Treasury rates rise, the rate borrowers pay would too, though it would never exceed 6.8 percent. Such a proposal would represent a return to the policy of the 1990s and early 2000s, except the cap on the variable rate then was 8.25 percent.

This variable-rate-with-a-cap proposal would give borrowers a “heads-I-win, tails-you-lose” arrangement. If short-term rates stay low, borrowers benefit. If short-term rates rise, the loans convert to low, fixed rates and the borrower wins again. When short-term rates decline, the fixed-rate loan converts back to a variable rate, and the borrower wins again.

The policy effectively shelters borrowers from the financial tradeoffs that they would normally face when they choose between fixed and variable interest rates on loans in the private market. Variable rates are lower at first, but can go higher. Fixed rates might be higher on average, but they provide certainty.

The variable-rate-with-a-cap proposal doesn’t, however, make that fundamental tradeoff disappear. It just shifts the cost entirely onto taxpayers.

How much would taxpayers have to pay to provide borrowers with this no-lose insurance policy? According to sources on Capitol Hill, the Congressional Budget Office says it would cost $200 billion over 10 years.

To put this price tag in perspective, Congress could fund an $8,000 maximum Pell Grant (up from $5,550 today) for the next 10 years if it allocated an additional $200 billion to the program over that time period.

Still, there are other options for policymakers to modify student loan interest rates that would make meaningful improvements for borrowers without breaking the bank. One even generates savings (read more here).

Students and aid advocates would be wise to rally around some version of a more feasible interest rate reform proposal in the coming months. But if they really want to get behind a proposal that costs $200 billion, please make it one that supports the Pell Grant program rather than college graduates’ monthly budgets.

While Congress has debated extending the 3.4 percent interest rate on Subsidized Stafford loans issued this year to undergraduates, advocacy groups are gearing up for a debate on longer-term reforms. They know the odds don’t favor Congress adopting a one-year extension of the lower rate again next year. Besides, spending $6 billion to save college graduates $9 a month isn’t a great deal for borrowers or taxpayers. So it’s good that student aid advocates want a better plan. But they aren’t off to a great start. They are gathering support for an outrageously expensive proposal that turns a blind eye to far more worthy aid, like Pell Grants.

The student loan interest rate proposal that is dominating discussions among advocates and other stakeholders would provide borrowers with variable interest rates that would be capped at the current fixed rates of 6.8 percent on Stafford loans and 7.9 percent on PLUS loans for parents and graduate students.

The rate on all newly-issued federal loans would be adjusted annually based on interest rates on short-term (three month) U.S. Treasury debt, plus a markup of two to three percentage points to partially offset costs. Today, that would translate into an interest rate of about 3 percent. If short-term U.S. Treasury rates rise, the rate borrowers pay would too, though it would never exceed 6.8 percent. Such a proposal would represent a return to the policy of the 1990s and early 2000s, except the cap on the variable rate then was 8.25 percent.

This variable-rate-with-a-cap proposal would give borrowers a “heads-I-win, tails-you-lose” arrangement. If short-term rates stay low, borrowers benefit. If short-term rates rise, the loans convert to low, fixed rates and the borrower wins again. When short-term rates decline, the fixed-rate loan converts back to a variable rate, and the borrower wins again.

The policy effectively shelters borrowers from the financial tradeoffs that they would normally face when they choose between fixed and variable interest rates on loans in the private market. Variable rates are lower at first, but can go higher. Fixed rates might be higher on average, but they provide certainty.

The variable-rate-with-a-cap proposal doesn’t, however, make that fundamental tradeoff disappear. It just shifts the cost entirely onto taxpayers.

How much would taxpayers have to pay to provide borrowers with this no-lose insurance policy? According to sources on Capitol Hill, the Congressional Budget Office says it would cost $200 billion over 10 years.

To put this price tag in perspective, Congress could fund an $8,000 maximum Pell Grant (up from $5,550 today) for the next 10 years if it allocated an additional $200 billion to the program over that time period.

Still, there are other options for policymakers to modify student loan interest rates that would make meaningful improvements for borrowers without breaking the bank. One even generates savings (read more here).

Students and aid advocates would be wise to rally around some version of a more feasible interest rate reform proposal in the coming months. But if they really want to get behind a proposal that costs $200 billion, please make it one that supports the Pell Grant program rather than college graduates’ monthly budgets.

The topic of student loans is being debated in the Senate this week, with lawmakers on both sides of the aisle hoping to pass legislation that would curb rising interest rates. Without legislation, interest rates on federal student loans will double from their current rate of 3.4% to 6.8% beginning on July 1st. A recent article in the New York Times provides a good summary of this debate.