New Proposals for Hybrid Fixed/Variable Interest Rates on Federal Student Loans

Mark Kantrowitz

April 12, 2013

New Proposals for Hybrid Fixed/Variable Interest Rates on Federal Student Loans

The interest rates proposed for the unsubsidized Stafford loan — the 10-year Treasury rate plus 2.93% or 3.0% — are similar to the old CMT plus 3.1% variable interest rate that was available on PLUS loans made before June 30, 1998, but without any cap on the interest rate. Effectively the hybrid interest rates represent interest rate increases masquerading as interest rate cuts.

If interest rates were to return to pre-credit crisis levels, the interest rates on the unsubsidized Stafford loan will increase to about 8.0% under both proposals, much higher than the current 6.8% interest rate. (The interest rates on the subsidized Stafford loan will increase to 6.0% and on the PLUS loan to 9.0% under the President’s proposal and 8.0% under the Republican proposal.) But it could be even worse, since there are no caps. Based on 10-year Treasury rates from the early 1990s, the interest rate on the unsubsidized Stafford loan could be as high as 12.0%. (The interest rates on the subsidized Stafford loan will increase to 10.0% and on the PLUS loan to 13.0% under the President’s proposal and 12.0% under the Republican proposal.)

Both proposals would save the federal government tens of billions of dollars over a 10-year period, money that would be paid by future borrowers.

The Republican proposal would use the savings for deficit reduction. The President’s proposal would use the savings to expand eligibility for the Pay-As-You-Earn Repayment (PAYER) plan to all borrowers. Currently borrowers must have at least one loan disbursed in FY2012 or a subsequent year (on or after 10/1/2011) and no loans from prior to FY2008 (before 10/1/2007) to qualify for this repayment plan.

The President’s FY2014 budget also reintroduces a proposal to expand the Perkins loan program from $1 billion a year to $8.5 billion a year by turning it into an unsubsidized Stafford loan, designed to replace private student loan borrowing. The increased revenue from the unsubsidized Perkins loans would be used to fund an expansion in the number of Federal Work-Study jobs, doubling the number of Federal Work-Study jobs over a 5-year period. In the first year there would be 112,000 additional recipients of Federal Work-Study jobs, out of a total of 809,000 recipients, and total Federal Work-Study funding would increase by $150 million as compared with 2012.

Lack of Interest Rate Caps Yields a Bad Bargain

Trading off lower interest rates now for higher interest rates later is a bad bargain. Even if interest rate caps are added to the proposals to prevent double-digit interest rates, these proposals still draw attention away from the real problem, which is the growth in the amount of debt. New Stafford and PLUS loan debt will total about $117 billion in FY2014. Average debt at graduation continues to grow every year because of the failure of grants to keep pace with increases in college costs. The federal and state governments continue to cut their support of postsecondary education on a constant dollar per-student basis. The most effective way of making college more affordable is to reduce debt by increasing grants, not by tinkering with the interest rates.

The President’s FY2014 budget proposes to increase the maximum Pell Grant to $5,785 in 2014-15, up from $5,645 in 2013-14, a 2.48% increase. A total of 9.4 million students would receive Pell Grants. That’s a baby step in the right direction. But much more money is needed to make a dent in college affordability, not just a small $140 inflationary increase in the maximum grant. Instead of discussing the possible doubling of student loan interest rates, student aid advocates should be demanding that Congress double the maximum Pell Grant.

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