Democrats on the House Education and the Workforce Committee this week released a document detailing the increased costs to borrowers if interest rates on Subsidized Stafford loans increase from 3.4 to 6.8 percent, as they are scheduled to for loans issued as on or after July 1st, 2012. The post provides some big numbers, stating that “more than 7 million students will incur an additional $6.3 billion in repayment costs for the 2012-2013 academic school year if student loan interest rates double on July 1.” But the committee staff’s claim buries the real story: Whatever the vitriol surrounding the interest rate number in Congress, individual students are not likely to notice much difference in their monthly payments.
There wasn’t much detail accompanying the committee document, so Ed Money Watch has tried to recreate the Democrats’ calculations.
Because we don’t have access to student loan recipients and loan volume data for 2013 (the data the committee used) we relied on the Department of Education data on Subsidized Stafford loans for the 2011 award year, the most recent year for which data are available. This means that our numbers are slightly different than the committee’s numbers. We collapsed the data to get the total number of loan recipients and total loan volume originated by state (not for the state in which the borrower lives, but for the state in which the institution is located) and calculated the average loan per recipient in each state.
Next we used the Department of Education’s standard loan repayment calculator to determine the repayment period for each state, given its average loan size. Based on that repayment period, which ranged from 77 to 120 months, and accounting for the minimum $50 payment requirement set by the Department, we used an amortization calculator to measure the total interest paid on the average size loan in each state under both the 6.8 and 3.4 percent interest rates and calculated the difference between the two. It is important to note, that in most states, loans at the 6.8 percent interest rate had longer repayment periods than loans at the 3.4 percent interest rate.
We found that the difference in student interest payments varied by state depending on the average size of the loans. In Indiana, where the average loan size for 2011 was relatively low at $3,924, students would see an average increase in interest costs of about $772 over the life of the loan. In Pennsylvania, where students had an average loan size of about $4,509, interest payments would increase by just over $1,000.
These numbers may sound large, but there is a bit of an illusion because the figures condense 10 years of future repayments into one number. The impact on individual borrowers is far less significant when measured on a monthly basis.
In fact, according to our calculations, students’ minimum monthly payments would increase by, at most, about $9. To calculate this figure, we calculated the monthly payment on an average loan at 3.4 percent interest over the repayment period specified by the Department of Education to reach a $50 payment. Then we calculated the monthly payment for the same loan at 6.8 percent within the same repayment period. In states with high average loan sizes, like Illinois ($5,113), the $50 monthly payments would jump to $59 when the interest rate doubles but the term length is kept the same. States with smaller average loans (for example, South Carolina at $4,103) would see monthly payments increase from the minimum $50 to about $56. The national average would see students pay about $7 more a month over the same repayment period.
Another caveat: The 3.4 percent interest rate applies only to undergraduates, but we are unable to determine the total loan volume only for undergraduate students. It appears the House Committee did not break out the undergraduate data either, which would significantly overstate both the numbers of borrowers and the total loan volume – and therefore the combined increase in costs to borrowers of the interest rate change.
And there’s another factor that we don’t think the minority staff on the Committee took into consideration (though without their original data, it’s hard to say for sure): the time-value of money. The Committee has collapsed 10 years of future interest payments into one amount, but they have not discounted the future payments for the time-value of money. This exaggerates the real cost of the payments today. Put another way, the 1st and 120th monthly payments on a 10-year loan are not of equal value to the borrower today, even though the payment is fixed at $56.
To more fairly represent the additional cost of the 6.8 percent interest rate over the life of the loan in today’s dollars, Democratic committee staff should discount the future payments for the time-value of money. Of course, had the Committee chosen to simply show the increase in the monthly payments (a smaller number) rather than the value of all future payments combined, the discounting issue would have been moot. But the Committee can’t have it both ways.
We originally calculated that an average student at a school in Maine (a mid-range state in terms of loan size) would owe an additional $939 dollars in interest as a result of the increase to interest rates. After discounting the payments for the time-value of money, the net present value of those payments is just over $895. In California, where the average loan size was relatively high, students would pay an additional $965 discounting for the time-value of money, as opposed to $1,012 without accounting for the time-value of money.
The numbers the House Education and the Workforce Democrats released appear to be rooted in legitimate calculations. And there’s no denying that borrowers will pay more on their loans when rates go up. But the House Education and the Workforce Democrats probably overstate the story. Given that the state average increased cost of doubling the interest rate tops off at $9 a month per borrower, Congress and the President may not be taking on an issue as big as it first seems.
To see our calculations for all 50 states and the District of Columbia, click here.