The U.S. House plan to shift federal student loans from a low, fixed interest rate to one that would fluctuate throughout the life of the loan is not the way to encourage either college participation or smart personal finance. The Senate needs to hold out for a fixed-rate solution — or extend current rates until a more reasonable plan emerges. Making loan debt less predictable could just amplify the problem of growing student debt.
Rates for Stafford loans, the most common federally backed financial instrument for financing college, are due to double July 1 to 6.8 percent as a 2007 congressional provision that lowered rates expires. Republican leaders want to seize the opportunity to get the government out of the practice of setting interest rates.
The House voted last week along partisan lines to make interest rates on future subsidized and unsubsidized Stafford loans variable and tie them to the government's borrowing costs, plus 2.5 percentage points. Individual loan rates would be recalibrated annually and capped at no more than 8.5 percent. GOP leaders say it's a long-term solution that will end the politicization of loans and lower the program's cost. From Tampa Bay, Reps. Gus Bilirakis, Richard Nugent and C.W. Bill Young all voted for the plan.
The Republican formula is appealing in the short term, as the rate for Treasury bills has been hovering at around 2 percent (translating to a 4.5 percent loan rate). That's a better deal than a jump to 6.8 percent. But an improved economy is expected to send the T-bill rate soaring, which could mean dramatically higher interest costs for students long after they signed on the dotted line. The plan evokes the specter of the recent housing crisis, where unsophisticated buyers could only afford homes with the help of subprime rates and then lost their homes when rates escalated.
Already, the National Association of Consumer Bankruptcy Attorneys has warned that the student loan "debt bomb" — now at $1.1 trillion — will spur the country's next economic crisis. Increasing the uncertainty of loan costs could actually make it even less likely loans are repaid.
President Barack Obama has offered a more palatable plan, calling for fixed-rate loans where borrowing costs would be set, based on the T-bill rate, at the time of origination. And he proposes a lower additional cost, 0.9 percentage points, than the Republicans' 2.5. He also wants to expand the income-based loan repayment system that lowers payments based on borrowers' discretionary income and forgives debt after 20 years. He does not include a cap, which could expose students to rates much higher than 8.5 percent, though that would be apparent at loan signing.
A college degree remains a reliable springboard to economic security, explaining why, even as college costs have soared, low- and middle-class students are still willing to borrow money to attend. Seventy percent of the class of 2013 will graduate this year with debt from all sources averaging $35,200. There is an argument to be made that the low cost of loans has been one reason colleges have been able to continue to raise prices. But making loan rates variable, and loan costs less transparent, isn't a solution and risks further jeopardizing young people's financial future.
The Senate should insist the House join it in finding a better plan that ensures fair and predictable loan rates.