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Jul 8 2013   3:37PM GMT

Student Loan Rates Double: Sounds Bad, But…

Ed Tittel Ed Tittel Profile: Ed Tittel

There’s certainly been a lot of ranting and raving about Congress’s failure to keep Stafford loans at their historically low interest rate of 3.4 percent. And, as of July 1, rates on those loans have doubled, from 3.4 to 6.8 percent. I’d thought this to be an undeniable tragedy, until I heard Matthew Chingos of the Brookings Institution’s Brown Center on Education Policy, interviewed on NPR this morning (to hear the interview, check out “Congress Called On To Reverse Student Loan Rate Increase“).

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Upon reflection, I can’t see why student loan rates shouldn’t float on market conditions, as mortgage rates have always done.
(Image source: Fetcharate.com)

But it turns out this not may be as big a deal as it sounds at first. Among numerous items of interest that emerged from the Chingos interview, here are some high points:

  • affects only current college students taking out new Stafford loans after July 1, 2013
  • for typical borrowing over a 4-year period, the higher interest rate results in an average increase of $30 a month for loan payments
  • income-based repayment limits repayment on student loans to 15% of overall income, to cap overall outlays for those starting out in entry-level jobs

Chingos’ most important point — and one that I have to agree with upon further reflection — is that Congress should get out of the business of setting interest rates for student loans. The President, the Republicans, and some Democrats — alas, not those in the Sentate, who are holding things up at the moment — all agree that student loan rates should be pegged to some market benchmark (such as the Fed’s prime lending rate) and allowed to float with financial conditions. When interest rates go up, student loan rates should follow, and vice versa.

Gosh! This is how pretty much all other loan rates work, so although I can understand that students and their parents might want to see the historically low 3.4 percent rate extended, this puts taxpayers in the position of subsidizing student loans when rates go higher (as they are quite likely to do in the next year or two). Given that today’s prime lending rate is 3.38 percent, even a formula of “prime rate plus two percent” (a very standard rate for credit cards, mortgages, and other loan instruments) would still beat the automatic doubling to 6.8 percent, if it were to be adopted by Congress.

At a bare minimum, I’m relieved to understand that the current situation brought on by the sequester doesn’t necessary equate to financial ruin for students and their families for those seeking new Stafford loans. I’m even more relieved to learn that this affects only new loans, not the huge volume of existing loans already out through the Stafford program.

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