When the president signed the student loan deal restoring lower rates for student loans, there was bi-partisan agreement and applause. The politicians should stop patting themselves on the back. While lower rates are important, the overwhelming problem looms large: There is more than $1 trillion in outstanding student loans, while a generation graduates into a slow job market that makes repayment not only difficult, but impossible, for many.
The ultimate impact on the economy will rival the mortgage crisis. And it has its roots in the same soil: government subsidies that made people think they could spend more than they could afford. Now, they're finding out that like mortgages, student loans are no free lunch. And unlike credit card debt and mortgage debt which can be erased through bankruptcy and foreclosure, there is almost no way out of your student loans if you can't repay.
New Low Rates
The interest rate deal is good news. The bill that was just signed will keep rates on subsidized Stafford loans from doubling to 6.8 percent -- something that happened automatically on July 1st. Now retroactively to July 1, that rate will drop to 3.86 percent -- a rate that will apply through 2015 for all Stafford loans, both subsidized and unsubsidized.
Rates for graduate students will drop to 5.41 percent for graduate Stafford loans and parental PLUS loan rates will drop to 6.41 percent from the current 7.9 percent. Those rates will be in effect for the life of the loan -- though future loans could carry higher rates.
But that isn't the end of the story. Student loan rates are still very high -- and could go even higher as a result of this deal, since future rates will "float" according to treasury note rates.
Higher Rates Coming
As part of the deal to adjust the Stafford loan rate, the 2015 rates will be based on an adjustable rate formula, one that was discarded in 2008. For 2015 and subsequent years, the rates will be based on the 10-year treasury note rate (currently about 2.5 percent) plus 2.05 percent. That's pretty close to the newly agreed rate for all Stafford loans.
But, if the economy picks up and federal stops supporting lower rates, it's likely that treasury note rates could rise sharply. That will impact all borrowing -- from mortgages to car loans. And it would also translate directly into higher student loan rates under the new formula.
There will be a cap on how high the loan rates go: a cap of 8.25 for undergrad Staffords, 9.5 percent for graduate Staffords and 10.5 percent for parents' PLUS loans.
The Really Bad Deal
What a shame that formula wasn't in place for the past three years. During that period, rates on 10-year treasuries were as low as about 1 percent. When you consider that the government itself borrows for 10 years at a rate just slightly over two percent, you realize what a bad deal student loans have been over the past few years!
And that bad deal was made worse as the Congress has funnelled more money into the direct student loan program. As a result, until lately our colleges and universities have felt no competitive pressure to hold prices steady, or lower them, in order to attract applicants. Since so many students could get seemingly "free" money to pay for college, the market incentives to compete on price were removed.
Now, that's beginning to change. Universities are recognizing the need to hold the line on tuition -- and even making deals to offer steep tuition discounts for qualified early applicants. The change comes as parents and students finally realize the total cost of their education, including interest, over the years... and as they begin to question the benefit of a higher education amidst a tough job market.
Universities know they can't support their huge fixed overhead if they don't fill their classes. So in addition to tuition deals, they're cutting back on marginal course offerings, and starting to apply technology to compete with the growing trend of online education, and community college attendance. Finally, the marketplace is beginning to work.
Too Late for Today's Grad
But it's too late for those who have been snookered into graduating with a huge burden of debt, a burden for which there is little relief. Those who don't have income, or have low-paying jobs can go for the Income Based Repayment Plan, which reduces the immediate payment, but lets the interest burden grow.
And for those who pay on time and work in selected public service jobs for ten years can have their loan balances forgiven at the end of that period. Still, the burden is a heavy one. (For help understanding the alternatives visit Pay Back Smarter)
And in signing the bill, there is a threat that the problem could grow worse. The President said the government hasn't "done enough" to curb the rising costs of a college education, and will have some plans when the Higher Education Act is due to be re-written this fall. But as we learned with mortgage subsidies, and will soon learn with health insurance subsidies, more government "help" just creates expensive distortions.
Without the support of these student loan subsidies colleges would face pricing pressure from parents who rebel against paying exorbitant fees to have their kids sit in huge lecture halls taking notes. All that can be done online -- where students can have access to the best professors at very low cost. Or at a community college, where room and board costs are limited to the spare bedroom.
That kind of education revolution won't pay for ivy-covered buildings -- but it will put students in a far better financial situation when they get their degrees. They can then go out and work toward the future, instead of paying off the past. And that's The Savage Truth.