Calls Mount for Changing How Interest Rates Are Set on Federal Student Loans

April 09, 2013

President Obama's budget for the 2014 fiscal year, due out on Wednesday, is expected to propose moving to market-based interest rates on federal student loans.

Under current law, student-loan interest rates are set by Congress. On July 1 the rate on one type of loan will double, to 6.8 percent, unless Congress acts to avert the increase.

Congress already postponed the rate increase once, in the midst of the 2012 campaign season. Now, with the one-year reprieve about to expire on subsidized Stafford loans to undergraduates, some interest groups and members of Congress are calling for changes in how the rates on all types of federal student loans are set, to better align them with the government's cost of borrowing.

Last month the U.S. House of Representatives' education committee held a hearing that focused on a plan, proposed by the New America Foundation, to switch to a rate pegged to the 10-year Treasury note.

But some Democrats favor extending the current rate on the subsidized loans. Rep. Karen Bass, a California Democrat, has offered a bill that would permanently cap the interest rate on all federal loans at 3.4 percent. Senate Democrats would extend the 3.4-percent rate on subsidized loans indefinitely, though their budget doesn't include money for the plan.

On Tuesday morning several student-advocacy groups released a report arguing that the government should not profit on student loans, especially at a time when default rates are rising and many recent college graduates are struggling to find work. The report cites recent Congressional Budget Office projections that the government will make 31 cents on every dollar it lends to students next year, for a profit of $34-billion. (The budget office expects the profit to decline to 6 cents on the dollar as interest rates rise.)

In the report, the groups call on Congress to come up with a "comprehensive student-loan solution," or at least a "short-term agreement that is good for students" if a permanent fix "proves politically impossible."

Switching to a market-based rate could save taxpayers billions over the next decade, provided that rates rise, as expected. But it would probably cost taxpayers in the short term, while interest rates are low. It could also cause rates to rise on subsidized loans, at least above the current 3.4 percent.

To protect borrowers when market rates rise, student groups want to cap the maximum rate. Ethan Senack, higher-education fellow for the U.S. Public Interest Research Group, said his organization's priority was to come up with a policy "that is good for students now and good for students down the road."

Given the complexity of crafting a formula that's fair to both borrowers and taxpayers, there's a good chance Congress will put off changing the policy until the next reauthorization of the Higher Education Act, expected to begin next year.

On Tuesday afternoon, Rep. Joe Courtney, a Connecticut Democrat, introduced a bill that would postpone the interest-rate increase for two years, to give Congress "time to craft a thoughtful long-term solution to address this growing problem," according to a news release.

Correction (4/10/2013, 10:24 a.m.): This article originally misstated part of a plan proposed by the New America Foundation. Under the plan, student-loan interest rates would be pegged to the 10-year Treasury note, not the three-year Treasury note. The article has been updated to reflect this correction.