On Student Loans, No Deal is Better than a Bad Deal

To prevent student loan debt from getting even worse, student borrowers need loan reform that truly delivers lower costs than if no action is taken by July 1 and the rate doubles.
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When it comes to student loans, here's the story: The interest rate for subsidized Stafford student loans is scheduled to double on July 1, from 3.4 to 6.8 percent. Student advocates are calling on Congress to act before that deadline to cancel the increase and prevent students from taking on more debt. Unfortunately, under the guise of reform, some proposals are being put forward that would actually be even more expensive for students than a doubling of the interest rate.

To prevent the student loan debt crisis from getting even worse, student borrowers need loan reform that at the very least delivers costs that are truly lower than if the rate doubles to 6.8 percent.

The only proposal that meets this threshold and has been put to a vote is the Student Loan Affordability Act by Senators Harkin (D-IA) and Reed (D-RI). The Reed-Harkin bill extends the low 3.4 percent rate for two more years by closing $8 billion worth of corporate tax loopholes.

Nonetheless, a concept being floated by Senators Manchin (D-WV), King (I-ME), and Coburn (R-NC) is being hyped as "the" bipartisan compromise that we've been seeking. For senators looking to avoid accusations that they blocked a deal, this is great news. But for student loan borrowers and their families, this is terrible news.

That's because the architecture of this plan is fundamentally the same as that put forth in the House plan that passed on May 24, which student and consumer groups opposed.

First, the plan changes the current fixed interest rates (3.4 percent for subsidized Stafford student loans, 6.8 percent for unsubsidized Stafford student loans and 7.9 percent for parent and graduate loans) to variable rates tied to the 10-year Treasury bill rate. Borrowers would be assessed the 10-year Treasury bill rate plus additional interest, which this plan arbitrarily sets at 2 percent for Stafford loans, 3.5 percent for graduate loans, and 4.5 for parent loans.

The plan does not cap those student loan rates, meaning that student borrowers have no guarantee that their costs will stay reasonable. Indeed, current trends are not promising for students under this plan. According to projections by the Congressional Budget Office, rates for the 10-year Treasury bill will climb to 5.2 percent by 2018. And in fact, the 10-year Treasury bill rate is already on the rise, threatening to increase rates on borrowers even faster than anticipated. So, within four years, this plan would have subsidized Stafford student borrowers paying more than 6.8 percent. Within three years, parent loans would soar above the 7.9 percent rate.

The plan deceptively refers to the fixed interest rate of 8.25 percent that the federal consolidation loan offers as a "cap." A federal consolidation loan is no substitute for an interest rate cap because it provides no guarantee that a borrower's costs will be contained. For instance, it typically costs borrowers more to consolidate because it forces them to extend their repayment period, which causes them to pay additional interest. And accrued but unpaid interest is added to the loan balance during consolidation.

Most significantly, the plan aims to be "revenue neutral" over ten years. To understand this concept, envision a balloon being squeezed. While one part of the balloon gets thinner, the other part just grows, to the point that it just might burst. What this means is that any benefits delivered to borrowers in the form of low rates today will be paid for by future borrowers. A high school senior may benefit from lower rates than current policy while attending college next year, but his younger sister, currently in 8th grade, will pay for his low rates by being charged significantly higher rates.

And this plan doesn't simply rob Peter to pay Paul, as bad as that would be - it goes further. These rate hikes will generate $8 billion in additional federal revenue, more what would come in if the rate simply doubled to 6.8 percent. The Kline bill that passed in the House would generate $4 billion in savings that it would apply toward reducing the deficit - so this deal is literally twice as bad for students as the bad deal already passed by the House.

As the July 1 deadline looms, there will be more and more pressure on our senators to negotiate a deal just for the sake of delivering a deal. What we need is for Congress to pass legislation that delivers lower costs to students than what they would pay if the rate doubles. Anything else is just smoke and mirrors - and if that goal cannot be met, then no deal is better than a bad one that permanently increases borrower costs and worsens our student debt crisis.

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