Again the interest paid on student loans is in the news. The Senate left Washington for the Fourth of July Holiday without taking action on extending a bill which keeps interest rates low on student loans, but fear not, for they are never short of tricks. Politicians who have made their mark by pandering to voters can always made any laws passed upon their return retroactive. The repeated warnings that student loan rates will double on July 1 unless Congress prevents it may be causing unwarranted fears for people with college debt, the truth is the increase will only affect loans taken out on or after July 1.
Student debt became a hot button issue last year because it was an election year. At the time many news stories and press releases omitted or downplayed the fact that the impending rate increase would affect only one type of federal student loan: subsidized undergraduate Stafford loans. Again, just as last year, it won't affect other types of federal loans - such as unsubsidized Stafford loans, Plus loans for parents and grad students, or student loans made by banks and other private-sector lenders. Students typically take out new loans each academic year, and the rate increase will not apply to loans that have already been made.
In 2007 Congress cut the interest on Strafford Loans in half to 3.4% on the day it expires July1, it will just return to its normal 6.8% for new loans. Exaggeration of the effect on some 7,4 million students with low to middle incomes is a description that is pathetic and misleading. Sure it will not effect those financially better off because high income students are not eligible and/or do not need the loans. Just as bad is the terminology "fixing the problem" would cost six billion dollars for one year, again this is not a problem and it is not broken, the rate is just returning to normal. All this gets sticky because politicians have framed the issue in a way that stirs the voters emotions, a petition circulating online to forgive many student loans is gaining momentum and approaching one million signatures, this raises new questions, like one of fairness.
In 1988, Congress renamed the Federal Guaranteed Student Loan program the Robert T. Stafford Student Loan program, in honor of a Vermont U.S Senator Robert Stafford for his work on higher education. When we take a deeper look into the realm of student loans we find that 80% are Strafford Loans, all of these come directly from the government subsidized or unsubsidized they are often not enough to cover all a students college cost. No payments are expected on the loan while the student is enrolled as a full or half-time student. This "in-school deferment" continues for six months after the student leaves school either by graduating, dropping below half-time enrollment, or withdrawing. This is referred to as the grace period. Unpaid interest that is deferred until after graduation is added to the loan principal.
The government already effects the cost of higher education in many different ways. State governments subsidize the budgets of public colleges and universities. And federal and state governments give money to students through programs like Pell Grants and the American Opportunity Tax Credit. A below-market interest rate for Stafford Loans is just another subsidy mechanism. Like the government programs involved in supplying people with paid healthcare making cheap government loans available for education encourages people to consume more than they otherwise would. While many would argue that this is a good thing when it comes to education the policy also causes some negative distortions in that it encourages students at the margin, to choose more expensive educational institutions than they otherwise would, and to finance more of their education with borrowing. These incentives leave students burdened with debt and also makes them less focused on price than they should be.
When it comes to healthcare many people see governments intrusion into the market results in higher cost, the same can be said in education. Government loans are a driving force behind tuition inflation. Instead of extending the policy of holding Stafford Loan interest rates very low, it might be better to let rates go back up and redirect the cost of the subsidy into an expansion of Pell Grants and refundable tuition tax credits. This policy would keep the positive distortion associated with Stafford Loans such as allowing people get more education without the negative ones such as diminishing price sensitivity which causes them to borrow more money. The clear instinct of many politicians is to defend cheap Stafford Loans in an effort to be on the side of education. But subsidizing education need not mean subsidizing borrowing. We would be better off letting student loan interest rates rise and searching for other ways to drive down the cost of higher education with innovations like integration of more online classes and addressing the inflated price of books required for educational courses.
Footnote; Please check out my post below titled "Students Borrowing against the Future." It focuses on the dark-side of these loans, and the staggering size of this debt. Other related articles may be found in my blog archive, thanks for reading and comments are encouraged,