Federal Student Loans

With the federal government projected to make $1.4 trillion in new direct student loans in the next decade, the Congressional Budget Office recently published a report to provide information about the costs of the student loan program and its effects on the federal budget. Additionally, the report analyzes the budget impact of various options for changing  the terms on new subsidized loans and of modifying the overall system to setting interest rates on new direct student loans. 

Yesterday, the Congressional Budget Office (CBO) released a brief on student loan interest rates. It’s a treasure trove of information, and it adds new information to the debate in Congress over how to set interest rates on student loans. Here are five key points from the report.

1.      The Government Won’t Make Money on Student Loans

Student advocates and left-leaning think tanks say that the federal government makes money on federal student loans and therefore Congress should cut interest rates. The CBO has repeatedly warned lawmakers that those figures are wildly out of whack and it reports them only because it has no choice – the law requires it. According to both the CBO and many financial economists, a more accurate measure would better account for risk that taxpayers bear in making the loans. From the latest CBO report:

FCRA accounting [the official rules] does not consider some costs borne by the government. In particular, it omits the risk taxpayers face because federal receipts from interest and principal payments on student loans tend to be low when economic and financial condition are poor and resources therefore are more valuable. Fair-value accounting methods account for such risk and, as a result, the program’s savings are less (or its costs are greater) under fair-value accounting than they are under FCRA’s rules. On a fair-value basis, CBO projects that the student loan program will yield $6 billion in savings in 2013 and will have a cost of $95 billion for the 2013–2023 period as a whole…

To be sure, on a fair-value basis the loans make money for the government – but only for the next three years. And that is a good argument for reducing rates on loans issued in those years. But then the loan program flips to a large cost of $13 billion per year, on average, starting in 2016, more than erasing any gains. Why the big change from gains to losses?  It’s because the government charges the same interest rate on student loans no matter what is happening to interest rates in the economy. As a result, when rates are low, the loan program generates small profits; when rates are higher, as they are projected to be in the near future, and the economy is doing better, it provides relatively larger subsidies to borrowers at a cost to the government.

2.      Current Interest Rates Poorly Target Benefits

The best way to fix what the CBO calls subsidy rate variation is to peg interest rates on student loans to interest rates in the market – though the rates can still be held below-market. Such a plan would keep the size of the subsidy provided to students relatively equivalent, rather than providing a much smaller subsidy to students in a struggling economy. It would also reduce or eliminate any profits the government makes in low-rate years. According to the CBO:

There would be less yearly variability in subsidy rates under options that linked student loan interest rates to market rates than there is under current law.

Senate Republicans have a proposal to do that. President Obama does, too. House Republicans are on board. But both Republican plans only partially peg loans to market rates because they would cap interest rates at 8.25 percent. (The Senate Republican plan has a "hidden" cap that borrowers can trigger when they consolidate their loans once they leave school.) Both plans fall short of stabilizing the size of the subsidy in that regard. From the CBO report:

Imposing interest rate caps would increase the yearly variation in subsidy rates relative to options without caps. If a cap is binding—as would occur when rates on Treasury notes are high—interest rates on loans would be lower and the loans would receive a higher subsidy than they would without a cap.

3.      Senator Warren, Call Your Office: You’ve Been Outspent

Here is another revealing point in the new paper. It includes a hidden estimate of the cost of Senator Jack Reed’s proposal to reduce interest rates on student loans such that the program generates no “profit” for the government. Look at the estimated costs of the program under current law as show on the last line of Table 5 (and remember, these are under Federal Credit Reform Act accounting, not fair-value, so they’re not showing the true costs of the program). It shows savings of $184 billion over 10 years. The Reed proposal would effectively set the number to zero, meaning his proposal would cost $184 billion. And that’s not even the entire cost. That figure is for newly issued loans only. The Reed proposal would also let borrowers with old loans “refinance” into the new, lower rates his plan would set. That could easily add $50 billion, or even $100 billion, to the $184 billion figure.

Senator Warren, call your office. Senator Reed has sponsored the most expensive and most generous student loan proposal in Congress. You’ve been outspent by hundreds of billions of dollars.

4.      Option to Lock in Rates is Valuable

The CBO paper makes an important point about a provision in the House-passed plan, which provides borrowers with variable rate loans while in school, but allows them to lock in a fixed interest rate at any point during repayment.

The option to convert variable-rate to fixed-rate loans is valuable for borrowers and costly to the government because borrowers tend to convert when they believe interest rates will increase in the future. By contrast, when all loans carry fixed rates, there is no such timing incentive for consolidation.

Critics of the House-passed plan seem to have completely missed this point, as have the media. Providing borrowers with variable rate loans and an indefinite option to lock in a fix rate is a big benefit, albeit one that requires much more financial literacy on the part of students and borrowers.

5.      Interest Cap or Pell Grant? Take Your Pick

Also on the issue of interest rate caps, the CBO shows how much it costs to add them to various proposals. Capping rates at 8.25 percent adds a cool $40 billion to the cost of the fixed rate plans, like the one the President proposed. That is nearly enough to stave off the benefit cuts scheduled for the Pell Grant program in the coming years. All of the advocates and policymakers who insist that any proposal must have a cap should consider this:

Would you rather spend $40 billion arbitrarily capping interest rates for low-, middle-, and high-income borrowers, or shoring up the Pell Grant program for low-income college students?

The White House and House Republicans are arguing over two competing proposals to reform how the government sets interest rates on federal student loans. As we wrote two weeks ago, this is a good sign and a big improvement over the debate on the exact same issue from a year ago.

But if you are scratching your head trying to understand how the House plan and the president’s plan are different, it is because they are in fact very similar. Both tie rates to the market. The president’s plan only offers borrowers fixed rates, but the rate offered changes every year. The House plan requires different rates on the same loan while the borrower is in school, but then gives them the option to elect a fixed rate, which, like the president’s plan, is different depending on the year. Under the House plan, borrowers wouldn’t know unless they consolidate their loans exactly how much they owe.

Unfortunately, incomplete and inaccurate information about the pending proposals abounds. In this Ed Money Watch post, we publish an incomplete list of such information along with additional facts to bring more clarity to the debate.

This post was updated on May 31 and June 3 with additional entries.

The White House and House Republicans are arguing over two competing proposals to reform how the government sets interest rates on federal student loans. As we wrote two weeks ago, this is a good sign and a big improvement over the debate on the exact same issue from a year ago.

But if you are scratching your head trying to understand how the House plan and the president’s plan are different, it is because they are in fact very similar. Both tie rates to the market. The president’s plan only offers borrowers fixed rates, but the rate offered changes every year. The House plan requires different rates on the same loan while the borrower is in school, but then gives them the option to elect a fixed rate, which, like the president’s plan, is different depending on the year. Under the House plan, borrowers wouldn’t know unless they consolidate their loans exactly how much they owe.

Unfortunately, incomplete and inaccurate information about the pending proposals abounds. Below is an incomplete list of such information along with additional facts to bring more clarity to the debate.

The New York Times:

The [House-passed] legislation would cut the deficit by $3.7 billion over 10 years, a small but politically significant number, since White House officials say the deficit should not be reduced on the backs of indebted college graduates.

The New Republic:

Obama (whose own proposal is designed to be budget neutral; no additional spending on, or revenue from, student loans)...

Key Details Missing:

According to the Congressional Budget Office, the White House’s proposal would reduce the deficit over 10 years by more than the House proposal. The official figure is $6.7 billion. Why is that the case? The CBO estimates that the White House proposal would charge borrowers higher interest rates overall than the Republican bill passed in the House. If you add in the cost of the president’s proposal to expand a more generous income-based repayment plan to more borrowers, his combined proposal still reduces the deficit by $3.1 billion over 10 years, about the same as the House plan. To address The New Republic, the president's plan does include new "revenue" from student loans.

The New York Times should have called the White House on this hypocritical charge. The New Republic's account is wrong and one-sided.

The Institute for College Access and Success:

To make matters worse, [under the House-passed bill] the rate on every loan will change each year… This means the monthly payments required under most plans will change each year as well.

Key Details Missing:

Interest rates on the loans under the House plan do in fact change once a year after issuance, but borrowers my lock that rate in at any point after they have left school. Under the House plan, borrowers always have the option to choose a fixed rate (a free option) over a floating rate at any point during repayment. The interest rate and payments on the loans will not change if borrowers elect a fixed rate. While in school, the loans will carry interest rates that change once per year.

Under the president’s plan, borrowers would be issued fixed rate loans, but each loan would carry a different interest rate each year. (We proposed something similar). The difference in rates depends on the year the student borrows. This year it could be 5 percent, and next year the newly-issued loan could carry a rate of 7 percent, or even 4 percent, depending on where market rates go.

David Hawkings of CQ Roll Call:

But the GOP bill being passed today takes the [president’s interest rate] idea a significant step further — so much further, in fact, that the Obama administration has threatened a veto. While the House measure would link the rate to T-bills, as Obama proposed, it would set a much higher cap than the president on the maximum interest rate: 8.5 percent. [Emphasis added]

Key Details Missing:

David Hawkins for some reason believes the White House is opposed to the House plan because the interest rate cap in the House plan is too high, higher than what the White House would support. But the president’s proposal has no cap! None whatsoever.  The House proposal, at least in that regard, is more generous to students than the president’s plan. [We Tweeted at David to alert him to the error last week, but no correction has been run.]

USA Today:

The House Republicans' proposal would tie loan rates to the interest rate on a 10-year Treasury note, plus 2.5%, with a cap that would prevent the interest rate on Stafford loans from rising above 8.5%. Obama's proposal would have set the rate at slightly less than 1% above the Treasury note rate.

Key Details Missing:

The president’s proposal would in fact set the mark-up over 10-year Treasury notes at 0.93, 2.93, and 3.93 percent for Subsidized and Unsubsidized Stafford and Grad/Parent PLUS loans, respectively. Therefore, the 0.93 mark up is true only for Subsidized Stafford loans. On the more widely available Unsubsidized Stafford loans, the mark-up is actually higher under the president’s plan than under the House plan. The House proposes a higher mark-up Grad/Parent Plus loans than the president.

In short, the mark-ups are different for each loan type. That is an important detail that USA Today glosses over in a way that paints the president’s plan as more generous when the truth is more complicated than that.

Rep. George Miller in the Detroit Free Press:

Democrats compare the plan to predatory adjustable rate mortgage practices that helped fuel the housing collapse during the financial crisis. “We just saw that history in America. We saw what they did,” said Rep. George Miller, D-Calif., the senior Democrat on the Education and Workforce Committee.

Economists and academics have roundly dismissed the claim that variable rate mortgages had anything to do with the housing crisis. In the words of several Federal Reserve economists, “the data are not kind” to that narrative. They show that variable interest rate and fixed interest rate mortgages defaulted at the same rates, and that borrowers who had variable rate mortgages were paying the same interest rate when they defaulted as when they took out the loan.

Rep. Miller says, "we saw what [the variable rate mortgages] did," but what he says they did is entirely unsupported by actual data or research. The claim should be left out of both the housing crisis debate and the student loan debate.

The New Republic:

Keep in mind that the current [interest] rate has already produced record levels of delinquincy--[sic] the Department of Education announced last week that 11 percent of loans were 90 days or more past due.

Key Details Missing:

The New Republic has invented a novel explanation for student loan delinquency. No credible source or research has linked the current interest rate on federal student loans to the record levels of past-due loans. Readers will notice that The New Republic article includes 13 different links to substantiate its statements of fact -- but not on this one. And good luck finding one. Everyone accepts  large loan balances, the economy, or high unemployment as possible causes, but interest rates?

Mother Jones:

The GOP plan also includes no provision capping monthly payments according to income level, as Obama's does.

Key Details Missing:

All outstanding and newly issued federal student loans include a provision capping borrowers monthly payments according to income level. A more generous version of that benefit applies to all newly-issued loan under the president's proposal and the House proposal -- the two proposals share the exact same income-based repayment benefits for new loans. That is because those benefits are standard benefits already in law. The president would change the law to add the more generous version of the benefit in place for new loans to loans not affected by the interest rate changes, generally loans made prior to 2007, and the House would not, though the less-generous income-based repayment cap still applies to all loans. In other words, the GOP plan includes no provision capping monthly payments because one already exists in current law.

The Debate Continues On

In the coming weeks, the Senate is likely to consider its own proposals for setting interest rates on student loans. That will add more options into the mix, and more confusion. But here is a shortcut to understanding the different proposals: The president’s plan, the House-passed plan, and a leading bill sponsored by Senate Republicans really aren’t all that different from one another. Maybe that’s why there is so much confusion. The plans differ in only nuanced and technical ways, not in the broad ideological terms that might otherwise clearly set them apart.

The student loan interest rate debate will come to a head early this summer as the 3.4 percent interest rate on Subsidized Stafford student loans nears its July 1 expiration. When that deadline hits, the rate will revert to 6.8 percent, the rate currently charged on Unsubsidized Stafford loans. Last week, we published a piece detailing the half-dozen reform proposals currently floating around Capitol Hill and produced some takeaways on each. But there are still other misconceptions to clear up.

One of the current interest rate plans, Senator Elizabeth Warren’s (D-MA) proposal to reset Subsidized Stafford interest rates for just one year at the Federal Reserve bank lending rate of 0.75 percent, is perhaps the most controversial. Federal Education Budget Project Director Jason Delisle last week published an op-ed on Yahoo! Finance detailing one of the underlying problems with the plan: that the government already loses money on Subsidized Stafford loans. Delisle wrote:

What about Senator Warren’s claim that the government makes money off loans to low-income students?… She points to figures that the non-partisan Congressional Budget Office says “do not provide a comprehensive measure of what federal credit programs actually cost the government and, by extension, taxpayers.” In fact, when the budget office “accounts more fully… for the cost of the risk the government takes on when issuing loans,” it reports that Subsidized Stafford loans – those made to low-income students – cost taxpayers $12 for every $100 lent out, or $3.5 billion per year. If the loans cost $3.5 billion a year when the government charges a 6.8 percent interest rate, cutting the rate to 0.75 percent would more than triple that cost.

Warren’s claim that the government is profiting on student loans – and therefore that it should drop the interest rate it charges on federal loans for low-income students dramatically – is a rhetorical one. Delisle spoke to Dylan Matthews of The Washington Post’s Wonkblog to clear up the issue. Matthews writes:

Just like any institution, the CBO determines the cost of loans by “discounting all of the expected future cash flows associated with the loan or loan guarantee—including the amounts disbursed, principal repaid, interest received, fees charged and net losses that accrue from defaults—to a present value at the date the loan is disbursed.” To do that, it needs to settle on a “discount rate,” which is usually the expected rate of return on the loan in question. Banks and other private institutions generally estimate that by finding loans with similar risks and maturities to the one being evaluated, and then using those similar loans’ rates of returns.

The CBO does not do that. It discounts all government loans using the returns on Treasuries of similar maturity. So a 30-year student loan would be compared to a 30-year Treasury bond. But Treasuries are the safest bonds in the world... To capture the true risk of these loans, you’d need to discount using the rate of return for another loan with similar risk. Comparing them to Treasuries make them seem safe no matter what the actual risk.

The claims that student loans turn a profit for the government are based on unrealistic, rigged budgeting mechanisms. And looking at a fair accounting method, the one recommended by the CBO, it’s pretty clear that Subsidized Stafford loans are actually costing the government (and taxpayers) $12 for every $100 lent.  This may seem a wonky, insider issue, but with Congress under rigid fiscal constraints right now and members arguing that the U.S. needs to reign in the deficit, costs matter.

For more on how the government is losing money on these loans, check out this background page from the Federal Education Budget Project. You can also see the Wonkblog article here, and Delisle’s op-ed about Senator Warren’s proposal here.

Be sure to check out this op-ed on Yahoo Finance regarding Senator Warren's proposal to cut interest rates on federal student loans.

This Ed Money Watch post has a rundown of all of the pending proposals, including the one sponsored by House Republicans that will be up for a vote next week.

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.

The president’s fiscal year 2014 budget request includes a proposal for setting interest rates on newly issued federal student loans. The fact that the president excluded a cap in his proposal (as did the New America Foundation) has rankled student aid advocates. We’ve argued that the new income-based repayment (IBR) program that became available last year for students who began borrowing after October 1, 2007 ensures that a borrower’s monthly loan payments are capped – which therefore makes it a more generous benefit than an interest rate cap.

Read the rest of this post on Ed Money Watch.

In a hearing before the U.S. House Committee on Education and the Workforce this week, Terry Hartle of the American Council on Education (the higher education lobby) hinted that his association has had a major change of heart on income-based repayment for federal student loans. Or so it seems. 

At issue was a proposal by Rep. Tom Petri (R-WI) that would move the entire loan program to an income-based repayment system administered through employer payroll withholding. Borrowers would make payments at 15 percent of their discretionary income and there would be no loan forgiveness. Instead, total accrued interest would be capped at 50 percent of what a student borrows. Those terms are far less generous than the plan the Obama administration proposed in 2010 and enacted late last year, called Pay As You Earn or Income-Based Repayment. Under that plan, borrowers pay 10 percent of their incomes, 33 percent less per month than the Petri plan, and have their debt forgiven after 10 or 20 years.

Mr. Hartle told the Committee that the Petri proposal “could become an incentive to over-borrowing,” an outcome that he said, “no one wants.” If the Petri proposal more or less rolls back the Obama administration’s Pay As You Earn and Income-Based Repayment plans and replaces them with something that requires borrowers to pay more and for longer, one wonders what the American Council on Education’s position is on the Obama administration plan, which is in current law and available to nearly all new borrowers going forward.

Does Mr. Hartle believe the plan available now for recent borrowers encourages over-borrowing too? If so, that would be a new position for the American Council on Education.

When the president laid out the details of his Pay As You Earn plan in 2010, the American Council on Education rushed to send the White House a letter (available here). The Council’s letter expresses no concern about incentives for over-borrowing, despite the fact that the president’s program is far more likely to encourage over-borrowing (as outlined in this New America Foundation paper) than the Petri proposal because its terms are so much more generous for borrowers, mainly graduate students. The letter is a straight-up endorsement of the president’s proposal to “expand” benefits under Income-Based Repayment.

What explains the inconsistency in ACE’s “strong support” for the Obama administration’s plan and its cautionary warnings about over-borrowing under the Petri plan? (Maybe their position has evolved since they endorsed the Obama administration plan in 2010, and the group does in fact have concerns about it now.) It is unfortunate that the Committee didn’t think to ask Mr. Hartle to explain that glaring inconsistency.

Disclosure: The author worked for Rep. Petri from 2000 to 2005.

By Deanne Loonin

President Obama has committed his administration to achieving new levels of openness in government. When it comes to the Department of Education, however, there appears to be far more “talk the talk” than “walk the walk” in these efforts and the “new era” of open government looks a lot like the old way of doing business.

This disappointing record has serious implications for student loan borrowers and their advocates as basic information about Department of Education policy is harder than ever to obtain. 

Take, for example, the Department’s policy regarding the commissions it pays student loan collection agencies.