After interest rates on federal student loans temporarily doubled from 3.4 to 6.8 percent in July, the U.S. House and Senate voted to pass a bipartisan bill tying student loan interest rates to market rates, rejecting a plan proposed by Sen. Jack Reed, D-R.I., that would have frozen the rate at 3.4 percent for another year.
Though undergraduate loan interest rates are currently at 3.86 percent, they are projected to rise with the market environment, potentially reaching the law’s prescribed caps — set at 8.25 percent for undergraduates, 9.5 percent for graduate students and 10.5 percent for parents.
Reed said he worries that if the rates on federal student loans approach the caps established by current legislation, the effects for students and their families in the short-term, as well as for society in the long-term, could be devastating.
Looking for legislation
Interest rates were set to double to 6.8 percent from 3.4 percent last year as well, but Reed led a coalition that successfully passed legislation to freeze the interest rate at 3.4 percent for the year.
“The fix was worthwhile in exactly that degree — a year’s worth,” said Alex Mechanick ’15, president of Brown for Financial Aid.
When that temporary fix expired July 1, the interest rate for federally subsidized Stafford loans, designed for students with demonstrated financial need, doubled to 6.8 percent, affecting seven million students nationally and more than 47,000 Rhode Islanders, according to a July 10 press release from Reed’s office.
Following the rate increase, Reed joined with Sen. Elizabeth Warren, D-Mass., and Sen. Kay Hagan, D-N.C., to fight for reauthorization of his Keep Student Loans Affordable Act.
Reed and Warren called their piece of legislation a “two-pronged approach” in a Politico opinion piece they co-authored. The first part of the bill was meant to combat the impending doubling of the interest rate by using a “one-year patch” to freeze rates at 3.4 percent. The legislation also laid out principles to guide long-term reform in the student loan system, including “eliminating profits from student loans, stemming the rising cost of college and alleviating the burden of student debt on existing borrowers through refinancing and better consumer protection,” they wrote.
“We were proposing to freeze the rate at 3.4 percent so we could make some structural improvements to the program, but we were not successful,” Reed told The Herald.
The Senate rejected the Keep Student Loans Affordable Act 51-49 July 10 — failing to reach the 60-vote threshold needed to overcome a filibuster.
Though it wasn’t successful, Reed’s proposal was important in a time when the prevailing attitude in Congress is “that the government is always bad, and you have to rely on the private sector,” said Leonard Lardaro, professor of economics at University of Rhode Island.
Hitting the cap
In place of Reed’s proposal, the Senate passed the Bipartisan Student Loan Certainty Act of 2013, a variable rate system that tied student loan interest rates to market rates and allowed them to increase or decrease based on economic indicators. Though the bill lowered interest rates to about 3.86 percent and retroactively lowered the rates on loans that had temporarily doubled to 6.8 percent, the rates are expected to rise in this market environment, Reed’s staff said.
When President Obama signed the legislation, he called it a “common-sense approach to keeping student interest rates at a reasonable level,” the Providence Journal reported.
Though the market-based loan rate system in place from 1992 to 2006 kept rates reasonably low, market-based systems rely heavily on a reasonable cap to protect borrowers in high interest rate environments, and the caps in the legislation passed this summer are too high, according to Reed’s staff.
“As a result, the financial pain for students and middle-class families is essentially back-loaded to kick in later, with some rates projected to be above the current rate of 6.8 percent as soon as 2015, and rates for undergrads to rise above seven percent as soon as 2017,” according to a July 24 press release from Reed’s office.
An amendment from Reed, Warren and 17 Senate colleagues proposed locking in lower caps — 6.8 percent for undergraduate and graduate loans and 7.9 percent for Parent Loan for Undergraduate Students — but it was defeated.
“Every indication shows that rates will go up,” Reed said. “I think (reaching the cap) would be the worst situation right now.”
“It’s exceedingly unlikely” the rates will reach the caps near 10 percent, because “it would take roaring economic growth,” Lardaro said. “My impression is that although it’s unfortunate our Senator’s motion went down, I don’t think interest rates are ready to spike anytime soon,” he said.
But even if the rates reaching the cap is a “mute issue,” it is still a “question of fairness,” Lardaro said. Though a market-based system might be more efficient, a fixed-rate system like the one proposed by Senator Reed reduces the risk that interest rates will make it difficult for low-income students to pay back their loans, he said.
The efficiency-equity tradeoff
“The legislation raises questions not just about our economic future but the kind of people that we are,” Lardaro said. “I think that the market-based system will certainly be more efficient but the problem is that it won’t necessarily be equitable or fair.”
“There’s a much more fundamental issue (than efficiency) and that is the value of education, not just to the individual, but to society,” Reed said. “Markets don’t quantify social benefits very well. That’s why the government steps in and provides subsidies or incentives,” he added.
“Education is not like typical government spending. It’s investment-oriented spending that can actually allow the government to generate more tax revenue in the future,” Lardaro said. For example, the big boom after World War II can be attributed to the GI Bill that subsidized higher education for millions of veterans, he added.
According to projections, the current legislation will enable the federal government to “turn a profit on the student loan,” Mechanick said.
“What we have to do is make a judgment about whether or not the federal government should be making money off of student loans,” Reed said. One argument is that the government should be “lending at the lowest possible rate based on the cost,” Reed said. Another argument is that “in order to encourage higher education, we should actually think about subsidizing it.”
“The important question is not about the structure of the program, but how much we should be investing in students,” Mechanick said. “If we did more, would we be benefiting everyone in a way that would make it worth it?”
Roughly half of the jobs in the United States currently require a college degree, and predictions show that within a decade that proportion will increase significantly, Reed said. But while the demand for college degree has increased, so has the cost of tuition, he said.
“We have to get under control the cost of college education. The increase has been staggering,” Reed said. “Colleges have to step up, and we have to look at ways to encourage them to,” he added.
“The reason that we’re a productive economy today, and a more civil society, is because we’ve for hundreds of years supported education,” Reed said.
The most recent rankings of country performance in education, published by the Economist Intelligence Unit in November 2012, show that the United States has been surpassed in education performance by 16 other nations and currently ranks 17th in the Global Index of Cognitive Skills and Educational Attainment.
“Other countries have recognized investment in education as the path to prosperity and progress,” Reed said. “In this complicated global age, we’re going to have to have more college graduates.”
As student loan rates increase, “it increases the burden on a part of the population that’s already bearing an incredible burden,” Mechanick said.
For now though, it’s manageable, Lardaro said. “It’s certainly workable. We can live with it.”
A market-tied system also has benefits for students and parents because student loan rates “are more predictable and understandable,” said Megan McClean, director of policy and federal relations at the National Association of Student Financial Aid Administrators.
“If you have a broader sense of what’s going on, you can take the temperature of the economy and predict what the rates will be,” McClean said. “Before, it wasn’t connected to the outside world.”
NASFAA views the current legislation as a “strong piece of legislation that is good for all borrowers,” McClean said.
While past legislation, including the one-year freeze of interest rates at 3.4 percent last year, protected only Stafford loans, the new legislation “made the rates more affordable for everyone, not just the subsidized loan borrowers,” she said. Data shows that 80 percent of NASFAA’s subsidized borrowers also borrow unsubsidized loans, McClean added.
Though student loans go to individuals regardless of where they attend school, the burdens for different educational institutions will vary greatly, according to Reed’s staff. Universities with more students who are reliant on loans could start to see less tuition revenue and lower enrollment as rates increase, whereas independently wealthy institutions won’t face the same problems.
“I would assume that Brown is in a considerably better position than most,” Mechanick said. “That said, I think it’s a useless comparison. I think we should always be comparing ourselves to what we could be doing,” he added.
Where do we loan from here?
The caps are in place as a “safety net,” McClean said, but if rates reached them, “Congress might again look at interest rates and see if there is something else we could do.”
Changes might be made even by the end of the year in the process of reauthorization for the Higher Education Act of 1965, which will expire at the end of 2013, McClean said.
“That’s a process where lots of different aspects of higher education and student aid are considered,” she said.
Part of the current legislation has also required the U.S. Government Accountability Office to produce a report analyzing the costs and market instruments for student loans. The report has the potential to spark more ideas for long-term reform, according to Reed’s staff.
Though Reed’s and Warren’s amendment proposing to cap the rate at 6.8 percent was defeated, “once it gets past 6.8 percent we’re going to be down there reminding people,” Reed said.