Student Debt Crisis Still Needs Long-Term Solution

The interest rate on subsidized loans was maintained for one year, but Congress still needs a solution.

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Graduate students should consider paying off interest while still in school before taking out Graduate PLUS loans.
Graduate students should consider paying off interest while still in school before taking out Graduate PLUS loans.

It's been a big week in the nation's capital. All three branches of government were in the limelight: The Supreme Court upheld the Affordable Health Care Act (or most of it, anyway), and Congress approved a $127 billion transportation and student loan package to enact changes that were long-championed by the Obama administration.

[Read about student loan changes for 2012.]

Loyal readers of the Student Loan Ranger may already have guessed that this is the measure that would maintain the federal subsidized Stafford loan interest rate at the current 3.4 percent. But while the idea of maintaining lower interest rates may seem like a no-brainer, what is going on with the federal student loan program is much more complicated than it appears.

Here's a look at the background: In 2007, Congress agreed to temporarily and gradually reduce the interest rate on federal subsidized Stafford loans from 6.8 percent. Slowly but surely, the interest rate dropped to 3.4 percent rate in 2011, and was supposed to last through July 1, 2012. For the past few months, there has been pressure on Congress to figure out how to finance an additional cut that would maintain that rate. And last Friday, Congress voted to freeze the interest rate at 3.4 percent until 2013, essentially buying more time to avoid confronting and attempting to solve the student loan conundrum.

But is cutting the federal loan interest rate in half a viable solution to the student debt problem? We've written before how it would only apply to a small subset of loans available to only a portion of borrowers (since subsidized Stafford are only available to a portion of qualifying undergraduates), would only apply to new loans (not change the rate on loans already borrowed), and is only estimated to save even those borrowers an average $1,000 each, while undergraduates now graduate with an average of over $25,000 in educational debt.

To add to this limited scope, Jason Delisle, director of the Federal Education Budget Project at New America Foundation, says that while keeping interest rates as low as possible may be an attractive solution, it doesn't come without high costs for taxpayers. A solution he has proffered is what he believes to be a No-Cost Interest Rate Fix: pegging the interest rate to 10-year Treasury bonds and adding 3 percentage points.

Under this proposal today, the rate would amount to roughly 4.5 percent and would apply to both federal subsidized and unsubsidized loans. (Currently, the low 3.4 percent rate applies only to subsidized loans, while the majority of student do their borrowing through unsubsidized loans.)

[Read more about unsubsidized Stafford loans for graduate students.]

Because subsidized and unsubsidized Stafford loans currently have differing interest rates (3.4 percent and 6.8 percent, respectively), Delisle's scheme appears more advantageous to graduate students. Imposing the 4.5 percent interest rate would mean student borrowers could expect lower overall loan balances, because all Stafford loans would have a low rate, rather than a small subset.

Furthermore, Delisle says his plan will better serve both undergraduates and graduates who cannot capture the 3.4 percent rate. (Subsidized loans are not available to graduate students, and many undergraduates do not qualify for subsidized loans but do borrow unsubsidized loans.)

The 10-year Treasury note plan may also be able to manage the problem of financing the student loan program; the Congressional Budget Office reports that Delisle's plan could reduce the cost of the loan program by $52 billion over the next 10 years. Congress's extension costs $6.7 billion for only one year.

Delisle may have a winning plan on his hands, but only if the economy maintains status quo. If the economy improves, the interest rate on the 10-year Treasury notes will probably rise. Delisle says that it is a "fair approach to taxpayers and students" to offer a fluctuating interest rate, offering low interest rates during a weak economy and higher when stronger.

Is that really fair? Should students hope the economy doesn't improve and choose to face the obstacles of a limited job market just to keep interest rates low? Will borrowers accept higher interest rates with open arms because the economy is doing much better? To the Student Loan Ranger, the answer isn't clear.

For now, Congress has saved the 3.4 percent interest rate, and has saved these questions until next year when the rate will once again be on the table. It's a now or later game for the student debt crisis. The Student Loan Ranger hopes we'll begin to see some larger reforms sooner rather than later.

This week's Student Loan Ranger was written by Maria Saab, a rising third-year student at George Mason University School of Law working as a summer legal intern at Equal Justice Works. Prior to this position, Maria contributed her writing to Today's Workplace, a labor and employment law blog compiled by non-profit, Workplace Fairness.