A bipartisan group of senators (King, Manchin, Burr, and Coburn) is reportedly drafting a bill that would prevent interest rates on Subsidized Stafford loans from doubling on July 1. Their proposal would set market-based interest rates on all newly issued federal student loans. It looks similar to proposals from Senators Coburn (R-OK) and Burr (R-NC), President Obama, and the New America Foundation. How does the proposal compare to other options for setting rates? We decided to run the numbers.
The interest rates would be set at the 10-year Treasury yield plus a 1.9 percent markup for undergraduate loans; a 3.4 percent markup for graduate Stafford loans; and a 4.4 percent markup for Grad and Parent PLUS loans. Media reports indicate that the plan produces budgetary savings over 10 years with a 2.0 percent markup on undergraduate loans, and the bill’s sponsors are likely to further reduce the rates to ensure the compromise proposal is budget neutral. That puts the markup for undergraduate Stafford loans in the 1.9 percentage point range.
Using this information, we ran scenarios comparing the bipartisan Senate bill with an extension of current policy (3.4 percent Subsidized Stafford, 6.8 percent Unsubsidized), current law (both loan types at 6.8 percent), and the president’s proposal, which also pegs fixed-rate loans to the 10-year Treasury note but adds a different markup to that rate.
Our calculations are a bit more complicated than others so as to be more accurate. We account for the fact that undergraduate borrowers typically borrow both Subsidized and Unsubsidized Stafford loans. Our calculations are based on an undergraduate who borrows the maximum in both loan types.
And we account for the fact that lower interest rates on Unsubsidized Stafford loans reduce the amount of debt borrowers have when they leave school (interest accrues on these loans while borrowers are enrolled, so a lower rate means less interest added to the total loan balance while in school). That effect lowers a borrower’s monthly and total payments. We also hold the 2013-14 interest rate constant for four years of borrowing. We don’t profess to know where interest rates are headed; instead, we assume today’s rates are constant.
The tables below show the average interest rate at repayment, the debt at repayment, and the monthly payment under a 10-year fixed repayment plan under each interest rate scenario outlined above for an undergraduate who borrows the maximum. The bipartisan Senate plan provides nearly identical terms as the president’s plan when translated into monthly payments, though the Senate plan has simplicity going for it—both loan types have the same interest rate. More importantly, both plans would be better for students this year than letting the 3.4 percent rate expire, or even extending it.
The bipartisan Senate proposal could increase the budget deficit by $30 billion in the next five years, a cost that some Senate Republicans are willing to swallow in exchange for a market-based rate. That sure looks like the bipartisan compromise that everyone says they want to see more of in Washington. Amazingly, other Democratic lawmakers cannot decide if a $30 billion rate cut is enough, because interest rates might, sometime in the future, on average, end up higher under the proposal than under current law, negating that new spending. They are, in other words, holding out for a sure thing and more money to boot. But what if rates stay lower for longer? By holding out for more, Democratic lawmakers will have torpedoed their only chance at providing students and parents a shot at those lower rates.
Student advocates and Democratic lawmakers may be looking a gift horse in the mouth.