A clear divide has emerged in the debate over the interest rates on federal student loans. In one camp are House and Senate Republicans, along with President Obama; in the other are the congressional Democrats. But before explaining what makes those camps different, a quick refresher on the interest rate issue is in order.
Undergraduates are currently charged two different fixed interest rates: 3.4 percent on Subsidized Stafford loans and 6.8 percent on Unsubsidized Stafford loans. Loans issued on or after July 1, 2013, though, will carry the 6.8 percent rate. (That policy has its roots in a 2006 Democratic congressional campaign and you can read the history here.) The rates are different for graduate students and parents of undergraduates, and were never subject to the expiring policy. The two-rate policy on undergraduate loans was originally set to expire last year, but President Obama called for extending it for one year. Congress went along with that at a $6 billion cost.
Unfortunately, the interest rates on federal student loans are just numbers Congress made up (seriously). And in debating the expiring two-rate policy last year, lawmakers never tried to come up with a more rational approach. Instead, they just extended the made-up numbers. We criticized that approach and offered an alternative last year.
What a difference a year makes.
A real debate about student loan policy is now underway in Congress. House Republicans (Kline), Senate Republicans (Coburn), and President Obama have all put forth proposals to peg student loan interest rates to the rates on U.S. Treasury notes. While their proposals are all slightly different, these lawmakers have put forth proposal that would be permanent, fiscally sustainable, keep rates well below market rates for all borrowers, and ensure that those interest rates reflect economic conditions.
So here is where the divide in the debate emerges. Other lawmakers – House and Senate Democrats mainly – have proposed either gimmicky solutions, wildly expensive ideas, or a two-year extension of the made-up rates. A side-by-side table is available here.
- Rep. Courtney suggests a two-year extension of current policy.
- Senator Warren would set the rate at 0.75 percent, but only for undergraduates and only for Subsidized Stafford loans, and only for one year. The cost would be close to $12 billion, by our estimates. Senator Warren claims her proposal has something to do with an emergency lending program at the Federal Reserve, which is really just a rhetorical gimmick that has no practical effect.
- Senator Reed introduced a bill that requires the Department of Education to set the rates at the “cost” of the program, and let borrowers with outstanding loans refinance to those rates. That would drop rates to about 2% by our estimates (official cost estimates understate the cost of the program, so the rates would be artificially low). Even though the program would operate at “cost,” the reduced interest payments compared to current law would actually show up in the budget as increasing the deficit (i.e. as a cost) of about $175 billion over the next 10 years according to numbers released by the Congressional Budget Office yesterday. That is before factoring in the refinancing component, which could easily top $50 billion in costs.
We’ve received a lot of inquiries about the merits of all of these proposals. Obviously, the shortcomings of the congressional Democrats’ proposals need no further explanation. The president’s and the House and Senate Republicans’ proposals, on the other hand, are all a huge improvement over current policy – and a huge improvement over what lawmakers were discussing last year. None would be a step backwards.
That said, the House proposal gives borrowers the most options and protections – floating interest rates with the option to take a fixed rate and an interest rate cap – but those options and protections mean the proposal has a lot of moving pieces that will require a lot of explaining. It will also confuse borrowers, some of whom will inevitably make a bad choice on when to lock in their interest rate. The president’s proposal needlessly charges undergraduates two different interest rates just to score political points. The Senate Republican bill, on the other hand, has no complicated options and no moving pieces, or gimmicks to score political points.
Those should be guiding principles as Congress and the president work to finalize a bill by July 1.