Student Loan Interest Rates To Be Tied to Market, Government Borrowing Costs

John Boehner, Speaker of the U.S. House of Representatives (Wikipedia)
John Boehner, Speaker of the U.S. House of Representatives (Wikipedia)

Last week Congress moved to overhaul interest rates on federal student loans. Under a new, market-based approach, students will be charged interest based on the going rates for long-term government debt securities. The bill, which the President is expected to sign, results in low-interest loans today—but pricier ones in the future.

After months of debate, politicians had failed to stop student loan interest rates from doubling by July 1. The hike affected approximately one-fourth of federal loans. The new legislation reverses this unpopular rate hike, solving the short-term problem with a long-term fix: tying rates to 10-year U.S. Treasury notes.

The final bill also ties the outcome to the budget deficit, at the urging of the Obama administration and most Republicans. If there are any savings realized from the switch, they will be redirected to reduce the federal deficit.

The rates for undergraduate students are now 2.05 percentage points added to market-based rates. For graduate students, the add-on is 3.6 percentage points. Rate caps, in case of extreme spikes, will apply after a handful of Democrats successfully argued for these borrower safeguards.

Market-based ApproachFrom now on, the amounts students pay back on Stafford loans will depend on how much it costs for the government to borrow and the overall state of the economy. If the economy is doing well, interest rates will be higher; if it’s recessionary, rates will be lower, as seen in recent years.

The proposal represents a bipartisan compromise of plans floated by lawmakers and the White House. Each year, the interest rates on a given loan will be reset annually based on the low-risk notes’ rates. Right now, treasury yields are low, so the bill solves the immediate problem of July’s extreme rate hike.

While some student advocates celebrated the reversal of the hike, others noted the victory is likely to be short-term. For most, it will cost more to take out loans by 2015 or 2016.

Weighing InAccording to Republican House Speaker John Boehner, “Going forward, the whims of Washington politicians won’t dictate student loan interest rates, meaning more certainty and more opportunities for students to take advantage of lower rates.”

In contrast, Senator Elizabeth Warren, a Democrat from Massachusetts, said of the new law, “This is obscene. Students should not be used to generate profits for the government.”

Warren stated that the government will extract some $200 billion over the next decade as a result of higher rates.

According the Congressional Budget Office (CBO) and Department of Education, the federal government has earned $120 billion in profits on student loans over the last five years. It is expected to make another $184 billion in profits for new loans through 2023.

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