Here’s What’s Going on With Federal Student Loans

Source: http://www.flickr.com/photos/92166610@N08/

According to the American Institute of CPAs, there were nearly 39 million adults in the United States with student loan debt at the end of 2012 — a 70 percent increase from 2004. At an average of $24,803 per loan, the total amount of outstanding student debt was more than $950 billion, greater than the total of all credit card debt and second only to mortgages as a contributor to overall household debt.

This seems to be the function of two complementary problems: the fact that the cost of college has more than quadrupled over the past 25 years and that federally subsidized loans probably helped fuel the surge. Put one way, demand for a college education (real, perceived, or otherwise) has increased steadily over the past few years. The number of people attending college between 2000 and 2010 increased 37 percent, with much of the growth in full-time enrollment (compared to an increase of 11 percent in the previous decade).

There are no doubt shades of grey in this picture, but it doesn’t take a college education to see that when droves of applicants line up with cash in hand, colleges not only open up their doors but can also increase the cost of admittance with little or no repercussions.

debt-postersThe issue is a hot topic. If you ask around, most answers will probably fall on one side or the other of a clearly drawn line: That there is a tragic student debt crisis brewing in America or that borrowers should keep calm and take their medicine.

While in some ways it is fair to repeat the mantra that the burden of debt is on the borrower — buyer beware, a college degree isn’t what it used to be — it is not necessarily fair to denominate the return on investment on education in dollar terms. One of the major rubs with this issue is how much student loan programs cost the government (i.e. the taxpayer). Proponents have claimed the program a financial windfall, while critics suggest there are hidden costs that result in a net loss for taxpayers.

It is in this spirit that interest rates on subsidized Stafford loans doubled from 3.4 percent to 6.8 percent on Monday. This interest rate is currently set by Congress and is designed to ensure that students with demonstrated financial needs can afford a college education. However, the news that Congress was unable to find a way to prevent the increase — something that has proponents on both sides of the aisle — is a presumptive blow to the nearly 7 million students who are expected to take out new loans at the beginning of this academic year.

One of the primary arguments asks what the cost of money should be for students. Before the July 1 increase, Congress had at least five reasonable proposals on the table, but one side or another was able to torpedo any given plan.

At minimum, most proposals argued, students should pay rate determined by the market. This could be derived in a number of ways, but several proposals favored a rate tied to the benchmark ten-year treasury note, a proxy for the federal government’s own cost of borrowing.

There were (and, theoretically, still are) other proposals on the table that are a little more extreme. Senator Elizabeth Warren’s (D-Mass.) approach can be broadly described this way (source: TaylorMarsh.com):

StudentLoanGraphic

StudentDebtOther proposals, like the Smarter Solutions for Students Act — which was passed by the House on May 23, but that’s as far as it got — advocate a market-based approach to the rates. The bill would set rates based on the ten-year treasury note plus 2.5 percent, with a cap of 8.5 percent.

The Reed-Harkin Student Loan Affordability Act suggests that Congress will need as long as two years to put together reasonable student loan reform. According to the U.S. Senate Committee on Health, Education, Labor & Pensions, the Reed-Harkin Act of 2013 (S. 953) would “freeze need-based student loan interest rates for two years while Congress works on a long-term solution to slow the rapid accumulation of student-loan debt, and is fully paid for by closing three egregious tax loopholes.”

Those tax loopholes are the use of tax-deferred retirement accounts as a complicated estate planning tool, the use of expatriated entities to strip corporate earnings, and an oil and gas industry tax provision that treats oil from tar sands the same as other petroleum products.

“This is an issue of fairness. Instead of raising interest rates on families struggling to pay for college, Congress should close costly, special interest tax loopholes,” said Senator Jack Reed (D-R.I.).”This legislation will protect taxpayers and keep student loan interest rates affordable while ending wasteful subsidies for oil companies and reducing the amount of taxes lost to tax havens.”

Not to be left out of the fray, President Barack Obama laid out his own solution in the 2014 budget. ““Under current law,” it states (this was published well before July 1), “interest rates on subsidized Stafford loans are slated to rise this summer from 3.4 percent to 6.8 percent. At a time when the economy is still recovering and market interest rates remain low, the budget proposes a cost-neutral reform to set interest rates so they more closely follow market rates, and to provide students with more affordable repayment options.

“The rate on new loans would be set each year based on a market interest rate, which would remain fixed for the life of the loan so that student borrowers would have certainty about the rates they would pay. The budget also expands repayment options to ensure that student borrowers do not have to pay more than 10 percent of their discretionary income on loan payments.”

It’s a little dated at this point, but Marketplace spells out what happened on Monday.

Don’t Miss: Consumer Spending Is Not as Strong as Consumer Sentiment Suggests.

You can follow Dan on Twitter @WscsDan

More from The Cheat Sheet