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U.S. Student Borrower Advocates Say Tying Rate to Market Risky

Originally posted in Bloomberg.

By Janet Lorin

President Barack Obama’s budget proposal tying student-loan interest rates to the market is drawing criticism from education advocates because there’s no cap to protect borrowers when rates climb.

While the cost of borrowing in general today is low, there is a long-term risk for students, said Jennifer Mishory, deputy director of Young Invincibles, a Washington-based nonprofit group that advocates for the interests of 18-to-34 year-olds.

U.S. Congressman John Kline, chairman of the House Committee on Education & the Workforce, has been pushing for a return to market-based student loan interest rates. Source: via Bloomberg

“There must be a cap on how high those rates could go, otherwise students could be facing much higher debt levels and could be deterred from even going to school at all,” Mishory said.

Under Obama’s plan, rates on subsidized Stafford loans, which are for undergraduates from low-income families, would be set yearly based on the market and would be fixed for the life of the loan. Outstanding education debt is now at $1 trillion. As the cost to attend college outpaces the inflation rate for a fourth decade, more borrowers struggle to repay their debts. Rates on student loans are higher than on mortgages because they aren’t backed by any collateral and students often don’t have credit histories.

Rates on subsidized Stafford loans are set to double July 1 to 6.8 percent from 3.4 percent. Graduate students pay at a rate of 6.8 percent or 7.9 percent.

Students Struggling

If Congress can’t work out comprehensive student-loan reform before July 1, lawmakers should temporarily extend the current rate for subsidized Stafford loans, said Ethan Senack, a higher-education associate for U.S Public Interest Research Group, which advocates for students.

“The President’s proposal lowers rates in the short term, but pays for it with high rates in the future,” Senack said in an e-mail. “That isn’t investment. When students and families are struggling with record debt, we need more investment in higher education, not less.”

The rate for unsubsidized Stafford loans has been at 6.8 percent since July 2006. Rates on subsidized loans began to gradually decrease after July 2008, and have been at 3.4 percent since July 1, 2011. The initial reduction was passed by Congress in 2007 after campaign promises from Democrats during the 2006 mid-term elections, according to Mark Kantrowitz, who runs a website offering advice on education debt.

The cost to the government to implement the plan would be $25 billion in the first five years and would save $15 billion over 10 years, according to Jason Delisle, director of the federal education budget project at the New America Foundation, a Washington-based nonprofit public-policy institute.

GOP Bill

The long-term savings comes from government projections that 10-year Treasury rates will rise in the future, and that rates on future cohorts of student loans would be above 6.8 percent, he said.

Republicans also favor tying the loan rate to the market.

On Tuesday, U.S. Senators Tom Coburn of Oklahoma, Richard Burr of North Carolina and Lamar Alexander of Tennessee introduced a bill for all newly issued Stafford loans as well as PLUS loans for parents and graduate students to be tied to the U.S. Treasury 10-year borrowing rate plus 3 percentage points. The 10-year note yesterday yielded 1.78 percent.

“Moving to a market-driven approach will benefit both borrowers and taxpayers in the long-term,” Coburn said in a statement Tuesday. “Temporary fixes require annual patching and do nothing to solve the real problem. This bill provides a sustainable solution by eliminating arbitrarily dictated rates formulated by Washington politicians.”

Congressman John Kline, chairman of the House Committee on Education & the Workforce, also favors market-based student-loan interest rates.

Repayment Options

“My Republican colleagues and I have long believed returning to a market-based system for determining interest rates just makes sense, and will provide more stability for borrowers,” Kline said in a statement yesterday. “We look forward to a thorough discussion with the administration to determine whether the proposal outlined in the budget will effectively serve students, families, and taxpayers in the long run.”

Obama’s plan would also expand repayment options so borrowers don’t have to pay more than 10 percent of their discretionary income on student loans. The proposal calls for $1 billion in competitive Race to the Top grants for states that find ways to cut college costs and limit tuition increases.

The budget plan would provide $71.2 billion to the Department of Education, a 4.6 percent increase over the 2012 enacted level, according to the White House.