On Friday, President Obama once again took aim at the student loan crisis, accusing congressional Republicans of pushing a plan that would make college more expensive and, potentially, take it out of the reach of many lower-income students.
The battle over student loan rates — which the president noted is now in its second year — in many ways boils down to a question of economic responsibility. Currently, Congress sets the rate on federal student loans. If it raises the rates, loans become more expensive and, presumably, many students will opt out of going to college. If Congress lowers the rate, loans become less expensive and students will be more likely to stay in school. Both Congress and the president have offered proposals that would take this responsibility out of their hands, putting it on the market.
As those of us who went to school from the early 1990s through the mid-2000s can remember, student loan rates were once tied to U.S. Treasury bonds. When the interest rates on bonds rose and fell, loan interest rates followed suit. On the bright side, there was a cap, or limit, to how high the rates could go. Unfortunately, that cap was high — for a time, it topped out at 9 percent. By comparison, student loan rates currently range from 3.4 percent (for subsidized Stafford loans) to 7.9 percent (for PLUS loans).
Congress and the president are both proposing new guidelines that would tie the interest rate to the economy. Under the president’s proposal, 10-year Treasury notes would be the benchmark for loan interest. The interest rate on subsidized Stafford loans would be the Treasury note rate plus 0.93 percent; on unsubsidized Stafford loans, it would be Treasury rate plus 2.93 percent; and on loans to grad students and parents, it would be Treasury plus 3.93 percent.
Today, the Obama proposal would be a considerable benefit to students. It would lower the subsidized Stafford loan rate by 0.65 percent, the unsubsidized Stafford rate by 2.05 percent and the grad rate by 1.05 percent. The trouble is that the Treasury note interest rate is currently near historic lows and is almost certain to rise if the economic rally ever kicks into gear. As The Atlantic noted, there are times during the past few decades when — under the proposed plan — student loan interest rates would have jumped above 12 percent.
And, because, the president’s plan also doesn’t put a cap on interest rates, there would theoretically be no limit to how much students could end up paying.
The Congressional Plan
On the bright side, Congress’ plan puts a cap on interest rates: For subsidized loans, students couldn’t end up paying more than 8.5 percent; on unsubsidized loans, it couldn’t be more than 10.5 percent. And while these rates are quite high, they are still lower than the potential rates that students could be stuck with under Obama’s proposal.
But when it comes to the minimum rate, the Congressional plan falls down. Currently, the interest rate is determined when the loan is issued, which means that students borrowing money can count on a consistent rate for the life of their loans. Under the Congressional proposal, federal student loans would be variable rate, which means that the percentage that students would have to pay would fluctuate with the economy.
Rating the Proposals
Put another way, the rate issue boils down to an Obama plan, which would establish loan rates that could theoretically be extremely high but would not change during the duration of the loan. Congress, on the other hand, would establish rates that would be limited, but could go up or down, depending on the vagaries of the economy.
This variable rate could have an upside: When the economy is doing well and hiring is strong, rates would likely rise; conversely, when the economy is sluggish, rates would fall. For borrowers, this could translate into lower rates during hard times and higher rates during boom cycles.
By comparison, the current method, which establishes firm rates, is not responsive to economic ups and downs. Because of this, students who attend school during economic boom times but have to repay their loans during economic busts can easily find themselves trying to service high-rate loans at the worst possible times. This, incidentally, is a big part of the problem now: Many students who took out loans at 8 percent or higher during the 1990s and 2000s are in repayment mode when interest rates are low and hiring is sluggish.
Payback Is (But Doesn’t Have to Be) Hell
But if Obama’s loan rate plan is potentially problematic, his payback plan is very promising. Pay As You Earn, the president’s first stab at the student loan issue, was designed to ensure that students could not become enslaved by crushing loan debt. Instituted last year, the program caps student loan repayment levels at 10 percent of the borrower’s discretionary income, effectively ensuring that recent graduates won’t get stuck with brutal monthly payments. At the same time, the program also places an effective limit on the length of repayment: After a student has been paying off their debt for 20 years, the program will retire any debt that remains.
It’s a great idea, and could go a long way toward ending the student loan debt carousel that so many workers are stuck on. Unfortunately, there are some rather severe caveats. To begin with, Pay As You Earn is only available to students who have taken out at least one student loan after fiscal year 2011. In other words, most people who are already in repayment hell are stuck there.
Also, the program only applies to federally backed student loans, which means that many people struggling under the worst loan debt — those who took out higher-interest private loans — are ineligible.
Ultimately, the student loan issue bleeds across the economy, with ripples that go far beyond recent grads. As Obama noted in Friday’s speech, high student loan debt translates into lowered economic activity. As students struggle to pay their loans, they often aren’t able to afford to buy cars and houses and other consumer goods that would help boost the economy. With that in mind, the goal, ultimately, must be to make loan payments a reasonable and affordable part of a graduate’s budget, not a crushing burden that makes other expenses impossible. Under that rubric, however, both Obama and Congress’ plans are a failure.