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.

The PLUS parent loans made by banks and companies like Sallie Mae cost taxpayers 2.7 percent three years ago, the CBO estimated. Taxpayers will earn 17 percent back on the total amount of PLUS loans banks and other lenders make next year, according to the CBO. In the same period, taxpayer returns from parent PLUS loans made directly by the federal government—without going through middlemen—will have jumped from 9 percent to about 30 percent. The OMB is a little more conservative, estimating that PLUS loans made by banks next year will return to taxpayers about 5.5 percent, while loans made directly will return about 10 percent.

Part of the improvement is due to the 2006 switch from variable to fixed interest rates. But taxpayers are also benefiting from the same one-two punch that is pushing lenders like Student Loan Xpress to stop making education loans altogether. The Wall Street credit crunch drove up the costs of borrowing for companies, while Congress slashed the profit it guaranteed banks and other lenders who made Stafford or PLUS loans. The combination of higher costs and lower payments from the government has turned education loans into such money losers that a growing number of lenders have gotten out of the educational loan business entirely.

The companies' loss has been the taxpayers' gain—at least for now. The government is sending less money to lenders, and investors clamoring for a safe place to park their money have driven down the yields on treasury bonds, reducing the government's interest costs.

The interest rates on 10-year treasury bonds, for example, have fallen from 4.8 percent last May to about 3.8 percent today. The CBO estimates that administering the loan program and absorbing the costs of defaults adds 3 percentage points or so. That's why the 6.8 percent, 10-year Stafford loans are about break-even for the government these days. That's also why PLUS loans, which charge higher rates, are so profitable for taxpayers.

Unfortunately for taxpayers, the economic cycle that has reduced government expenditures on student loans may be nearing an end. The Federal Reserve has signaled it won't be cutting interest rates any more for a while, and it may even start raising them to rein in inflation. In addition, a few lenders have managed to persuade investors to buy student loan bonds, which could put further upward pressure on treasury rates. It might take a movement of only a couple of percentage points to turn even PLUS loans into a drag on the federal budget.