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Ed Money Watch

A Blog from New America's Federal Education Budget Project

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Cost Looms Large for Obama's Student Loan Interest Rate Cut

Published:  January 31, 2012

Note: This post was updated on 02/02/2012 with new cost estimate information.

Last week President Obama called on Congress in his State of the Union address “to stop the interest rates on student loans from doubling in July.” That line surely left a lot of people (Washington’s education policy circles not included) wondering what in the world the president was talking about. Is Congress really planning to double the interest rate on federal student loans this summer? The answer is yes, no, and maybe. In other words, it’s complicated. What’s more, a newly released estimate from the Congressional Budget Office shows that the cost of the president’s request will weigh heavily in any debate on the proposal.

Interest rates on Unsubsidized Stafford student loans, which are federal loans available to all students, issued for this academic year (2011-12) are fixed at 6.8 percent. The same rate has been charged on these loans issued since July of 2006. However, the interest rate is fixed at 3.4 percent for a subset of federal student loans – Subsidized Stafford loans for lower-income undergraduate students – issued this academic year. That rate is only temporarily available, and beginning in the 2012-13 academic year, the rate on that subset of loans will be the same as for Unsubsidized Stafford loans, 6.8 percent. So yes, rates are set to double for newly issued loans made to a subset of undergraduates after July 1, 2012.

The seeds for the coming rate change were planted way back in 2006. In their 2006 campaign platform, A New Direction for America, House Democrats promised to “slash interest rates on college loans in half to 3.4 percent for students and to 4.25 percent for parents.” By the end of 2007, they had (technically) made good on their promise. But just like those credit card offers that promise a low interest rate, the rate cut was enacted with important details listed only in the fine print.

Once lawmakers realized that their campaign promise would, according to the Congressional Budget Office, cost $133 billion over ten years (a substantial sum), they opted to scale it back dramatically. That’s where the fine print comes in.

To reduce the cost of the rate cut, Congress cut rates in half only for a subset of loans – Subsidized Stafford loans – which are available only to borrowers from families with middle and lower incomes. While graduate and undergraduate students were previously eligible for Subsidized Stafford loans, the law made only undergraduate students eligible for the rate cut. It left rates unchanged for the larger Unsubsidized Stafford loan program as well as for PLUS loans for parents and graduate students despite their inclusion in the campaign pledge. Even so, those caveats still didn’t get the cost of the proposal down to the size lawmakers wanted.

So to further reduce costs, Congress slowly phased in the interest rate cut over four years and then turned it off such that only loans issued for the 2011-12 school year would carry rates of 3.4 percent (half of 6.8 percent). Subsidized Stafford loans issued to undergraduate students after that year would again carry a fixed rate of 6.8 percent. In short, the 2007 law “cut interest rates in half” for loans issued only this academic year – and only for certain undergraduate students.

As President Obama demonstrated in his address last week, the rate cut issue will loom large this election year and Congress will be under a lot of pressure to stave off the rate hike. Of course, if lawmakers thought the 3.4 percent rate was too costly to make permanent back in 2007 at $3.0 billion a year, it won’t be any cheaper to do it this time around. In fact, it will be a lot more expensive. An early estimate from the Congressional Budget Office says extending the rate cut for one year will cost about $5.9 billion and $45 billion to extend it for ten years.

That’s why President Obama has requested only a one-year extension of the rate cut. Sadly, that’s exactly the type of shortsighted policymaking that got us here in the first place.

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