June 28 2012

Defrosting the Federal Student Loan Interest Rate Freeze

Vicki E. Alger

The interest rate on federally subsidized student loans is set to double from 3.4 percent to 6.8 percent on July 1 absent Congressional action. Just before 1:00 a.m. this morning, Sens. Barbara Boxer (D-CA) and Jim Inhofe (R-OK) announced they had a reached a deal on extending federal highway funding for two years, rather than the anticipated one year. It also includes extending the 3.4 percent interest rate on select federal student loans.

The House Rules Committee will vote today on the Surface Transportation Extension Act of 2012 (H.R. 4348), and floor action is expected shortly thereafter. (See pp. 590-91, Division F—Miscellaneous Items, Title III—Student Loan Interest Rate Extension.) Select changes include:

 

 

 

 

  • This change is expected to save $1.2 billion of the extension’s $6 billion cost. Another $5.5 billion in savings would reportedly come from changes to federal pension insurance.

 

The trouble is that $1.2 billion was supposed to help offset the looming 2014 Pell Grant program shortfall. (For more on Pell-related problems, see here and here).

Senate Finance Committee Chairman Max Baucus (D-Mont.) hails the student loan interest rate extension, saying that it “will also make a high-quality education affordable for millions of students across the country.” The details tell a different story.

Back in 2007 the College Cost Reduction and Access Act implemented a five-year, phased-in interest rate cut on federal student loans from 6.8 percent in 2006 down to 3.4 percent in 2011. Depending on when loans since 2007 were disbursed, the interest rates vary from 6.8 percent for 2007-08; 6.0 percent for 2008-09; 5.6 percent in 2009-10; 4.5 percent for 2010-11; to 3.4 percent for 2011-12. Regardless of whether or not Congress acts, none of those loans issued before July 1 will be affected—much less doubled. At issue is a one-year extension of the 2011-12 interest rate of 3.4 percent for undergraduates taking out Stafford loans for the upcoming school year—a subset of a subset of college students numbering around 6 million or 7 million.

Last week President Obama gave a statement equating college affordability with extending the 3.4 percent interest rate. "If Congress does not get this done in a week, the average student with federal student loans will rack up an additional $1,000 in debt over the coming year…more than 7 million students will suddenly be hit with the equivalent of a $1,000 tax hike."

White House Press Secretary Jay Carney echoed the college affordability theme in response to news that Congress is nearing an interest rate agreement: "We're pleased that the Senate has reached a deal to keep rates low and continue offering hardworking students a fair shot at an affordable education."

But here’s the reality. Extending the 3.4 percent interest rate for an additional year would save those students about $7 or $8 a month, possibly even $9 or $10. It would cost taxpayers $6 billion and still do virtually nothing to make college more affordable.

College tuition prices alone increase about twice the general inflation rate based on statistics going back to 1958. Examples of administrative and other forms of higher education bloat are plentiful. A recent analysis indicates that over a fifteen-year period postsecondary administration grew more than twice as much as instructional staff. This is significant since dozens of mid-level and senior-level administrative positions command six-figure salaries, compared to the relative handful of faculty positions that do. Meanwhile, six-year college completion rates at public four-year institutions have remained just below 55 percent for a decade. The four-year rate has been stuck around 30 percent.

Increased federal subsidies did little—if anything—to keep college affordable or productive. In fact, a strong case can be made that federal loans and aid likely fueled this situation instead of squelching it. (See here, here, here, here, and here.)

College students—and the taxpayers who support them—deserve real change, not spare change.

Rather than tinkering around with selective loan interest rates, the policy focus should be on key college affordability basics. Demanding taxpayer subsidized institutions provide accurate, actionable information, including details about how their graduates fare in the job market. Requiring postsecondary institutions to earn the subsidies they receive by implementing outcomes-based funding models that finance schools based on course and degree completion instead of enrollment. Fostering meaningful competition for students by allowing innovative alternative higher-education providers—including online course providers—to operate, which introduces powerful pressure on all institutions to be efficient. More innovative student financing ideas include allowing investors to finance college students’ education in exchange for a portion of their incomes after graduation (sometimes referred to as human capital contracts).

Reforms such as those would do much more than any one-time, one-year interest rate freeze to make—and keep—college affordable.

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