Student Loans Make Money for Taxpayers

Revised on 5/21/08: An earlier version of this article said the government has generated extra money from PLUS payments. The additional money has come from the government's reduction in subsidies to lenders last year.

As banks and private lenders quit offering what they say are money-losing educational loans, one group is making nice profits from some student and parent borrowers: taxpayers. Government agencies estimate that for every $10,000 a parent or graduate student borrows through the federal PLUS loan program in the next year or two, taxpayers will collect anywhere from about $600 to $3,000 above the total cost of the loan by the time the debt is repaid.

Ironically, taxpayers are reaping healthy 5.5 to 30 percent profits on PLUS loans for the same reasons private lenders are losing money. The government has saved money by requiring lenders to send the government a higher percentage of each PLUS payment. And the credit crunch that has raised borrowing costs for private companies has lowered federal interest rates.

That's why PLUS loans are still the cheapest option for many parents. PLUS loans made directly by the federal government charge a fixed 7.9 percent in annual interest and an additional 4 percentage points in upfront fees, for a total annual percentage rate of 8.8 percent. Some private loans are advertising initial rates as low as 5 percent for people with excellent credit. But most borrowers would be charged several points more than that because they have less-than-perfect credit records. In addition, most private loan rates are variable, so payments will rise when other interest rates bounce up. Finally, private loans don't offer PLUS loans' free insurance or flexible repayment options and won't be reduced if a grad student takes a public service job.

As taxpayers, parents are glad that the PLUS program reduces tax burdens, but James Boyle, president of College Parents of America, says that the potential size of the profits raises concerns. "PLUS loan margins need to be watched closely, so that greater benefits go to parents and not the U.S. Treasury," he says. Rep. George Miller, chairman of the House Committee on Education and Labor, noted that the extra money generated from last year's reduction in subsidies to lenders helps increase Pell grants for lower-income students and funds loan repayment programs for public servants and borrowers who end up in low-paying jobs. And that makes "college more affordable for millions of Americans," he says.

The gains from PLUS loans also offset losses from student loans. Undergraduate and graduate students who qualify as needy and thus get a subsidized federal Stafford loan in the next year or so will end up paying back about 16 percent less than the loans ultimately cost taxpayers, according to estimates by the Congressional Budget Office and the Office of Management and Budget. Subsidized Stafford loans cost taxpayers because they don't charge any interest while students attend college. These loans also charge only about 6 percent annual interest once the student leaves school.

Any student who doesn't qualify as needy can take out an "unsubsidized" Stafford loan, which is likely a wash for taxpayers. Those students are charged interest of 6.8 percent a year—and the interest builds up while they are in school—plus 1 to 2 percent in upfront fees, raising the total annual percentage rate to about 7.2 percent. The OMB estimates those loans cost taxpayers about 3 percent, but the CBO estimates taxpayers will make about 2 percent on those loans.

Because the government lends about five times more in costly subsidized Stafford loans than it does as PLUS loans, the entire federally guaranteed educational lending program is projected to cost taxpayers about 2 percent next year, the CBO and OMB agree. In a March analysis—its most recent of the federal education loan program—the CBO estimated that the federal government will make $73.2 billion worth of educational loans in 2009. By the time all those loans are repaid, the loans will very likely have cost taxpayers about $1.7 billion more than the government received in principal, interest, and fees. That's nevertheless a dramatic improvement for taxpayers. As recently as 2005, federal education loans were much less advantageous for taxpayers.