The Higher Price of Higher Education

Students, Your Loan Interest Rate Is About to Double

By Kayla Webley | Time Magazine Online, March 20, 2012

Prepare yourself: on July 1, as many as 8 million college students will see their interest rates on federally subsidized student loans double, from 3.4% to 6.8%. According to the U.S. Public Interest Research Group, that increase amounts to the average Stafford loan borrower’s paying $2,800 more over a standard 10-year repayment term for loans made after June 30.

It’s worse for those students who take out the most money. Those who borrow the maximum $23,000 in subsidized student loans will see their debt load upped by $5,000 over a 10-year repayment plan and $11,000 over a 20-year repayment plan.

With the deadline looming, college students last week delivered some 130,000 letters to Congress, urging legislators to keep the interest rate at 3.4%. Like many things in Washington this election year, the issue has become a partisan battle. President Obama and other Democrats have urged Congress to act to extend the low rate (Democrat Representative Joe Courtney of Connecticut has introduced legislation that would stop the rate hike), while Republicans favor allowing the rate to return to 6.8%. Even the cost estimates vary: Democrats predict that keeping the rate at 3.4% for one additional year would cost about $3 billion, while Republicans say it would cost nearly $7 billion. (Mark Kantrowitz of FinAid.org estimated the cost at $5.6 billion for one year.)

At the outset, doubling the interest rate seems like a really bad idea. The percentage of student loan borrowers in default is on the rise as student debt outpaces credit card debt. Students are already graduating with a record-high average debt of $25,000. And last year, for the first time ever, the total amount of student loans taken out topped $100 billion, and the total outstanding student loan debt is expected to top $1 trillion this year — also a first.

But the increase isn’t quite as devastating as it has been portrayed. To start, the 3.4% rate has been in effect only for one year. The rate decrease was passed by Congress in 2007 when Democratic legislators made good on campaign promises and passed the College Cost Reduction and Access Act. After the law passed, the interest rate on subsidized loans fell each year until reaching 3.4% this year — the same year it was set to expire.

Second, 6.8% is still a pretty low interest rate. Sure, 3.4% is better, but when compared with private student loans, which average 9% to 11%, and credit cards, which can have interest rates as high as 30%, 6.8% doesn’t sound all that alarming. (The interest rate for unsubsidized Stafford loans remains at 6.8%.)

The fact is, Congress is still dealing with a tight budget, and footing the bill for an interest-rate reduction is an expensive proposition. According to Kantrowitz, even in 2007, when the budget was more flush, legislators backpedaled on their campaign promises and cut the rate only on subsidized Stafford loans, rather than on all federal student loans, once they discovered how expensive it was to reduce the interest rate.

In the worst-case scenario, keeping the rate at 3.4% would create a vicious cycle. If the government put up the billions required to keep the rate low, they would likely be forced to turn elsewhere to tighten the belt. One of the potential targets, according to Kantrowitz, is the Pell grant, which is relied on by low-income students and has already sustained cuts. “Cutting Pell grants to maintain a low interest rate doesn’t make any sense,” Kantrowitz says. That’s because cutting grants would essentially force students to take out more loans, thus increasing their debt load. “If that happened, the government would essentially be taking away money from students with one hand and giving it back with another,” Kantrowitz says, adding that, in the end, allowing the interest rate on federally subsidized Stafford loans to return to 6.8% is the lesser of two evils.