College & Workforce Readiness

Obama Proposal on Student Loans Draws Fire

By Alyson Klein — April 23, 2013 6 min read

The Obama administration has found itself at odds with a key voting block—college students and their advocates—as well as many of its Democratic allies in Congress, because of an important, if technical, budget proposal that could have significant implications for college access.

In a move intended to stave off a doubling of interest rates on federally backed Stafford Loans over the summer, the administration is seeking to shift those interest rates from the current predictable, fixed-rate system to a market-based rate at the time of the loan. Right now, interest rates on subsidized Stafford Loans are set at 3.4 percent, but they’re slated to jump to 6.8 percent in July, unless Congress and the administration act.

Cap Off

The shift to a 6.8 percent fixed rate could cost a student with $20,000 in debt—roughly the national average—an additional $12,000 over the life of their loan, according to an analysis by the Institute for College Access and Success, a nonprofit organization in Oakland, Calif.

The administration and some Democrats in Congress have very different ideas about how to head off that potential rate increase. Advocates for students agree that under current interest rates, which are at historic lows—for instance, the rate was 1.73 on April 17—President Barack Obama’s fiscal 2014 budget proposal offers a better deal for borrowers than they’re getting right now.

But the proposal doesn’t place any cap on the interest rate, leaving students open to much more expensive loans if interest rates soar in the future, critics argue.

Just hours after the Obama administration released its budget blueprint April 10, a coalition of student-advocacy groups including the National Campus Leadership Council, U.S. PIRG, Our Time, Rock the Vote, and the Young Invincibles put out a joint statement disparaging the loan plan.

Drawing Interest

The Obama administration’s fiscal 2014 budget proposes big changes for federally-backed student loans.

• Rates on federally-backed student loans would shift from a 3.4 percent fixed rate to a market-based rate.

• These new variable rates would be based on the 10-year Treasury note, plus an additional 0.93 percent for subsidized Stafford Loans, 2.93 percent for unsubsidized Stafford Loans, and 3.93 percent for loans taken out by parents. The rate would be fixed for the life of the loan.

• If Congress does not act on the administration’s proposal—or pass an alternative—rates on student loans will jump to 6.8 percent this summer. That could cost the average borrower an additional $12,000 over the life of the loan.

SOURCES: U.S. Department of Education; Institute for College Access and Success

“Students have never taken out federal student loans without a cap on how high interest can go,” they wrote. “The president stood with us by investing in higher education during his first term, and we’re concerned that his budget does not deliver the same investment this time around.”

Key members of Congress are on their side. U.S. Sen. Tom Harkin, D-Iowa, the chairman of the Senate Health, Education, Labor, and Pensions Committee, said during an April 16 hearing on college costs that he has “serious concerns” about the proposal.

“Shifting all federal student loans from a fixed rate to an unrestricted market-based rate will increase the vulnerability of middle-class students and families struggling to afford a higher education,” Sen. Harkin said.

However, congressional Republicans—including the top GOP lawmakers in Congress on education issues, Sen. Lamar Alexander of Tennessee and Rep. John Kline of Minnesota—are on roughly the same page as the administration. They like the idea of moving to a market-based interest rate. In fact, Sen. Alexander said at an April 17 hearing that he would like to get started on legislation sooner rather than later.

“Today’s students shouldn’t be paying more than they should, and then, in the future taxpayers wouldn’t be subsidizing more than they should,” Sen. Alexander said.

Implications for Access?

Under the president’s proposal, student-loan interest rates would be tied to the prevailing rate of the 10-year Treasury note at the beginning of the academic year in which the loan is taken.

Students would be protected to some degree from a big spike in interest rates in the future, thanks to another provision in the budget request that would expand so-called income-based repayment plans for federally subsidized borrowers. The proposal would ensure that graduates don’t have to spend more than 10 percent of their income on loan repayment, no matter how much they owe in federally backed loans, or where interest rates stood when they borrowed the money.

Expanding income-based repayment plans is a “more effective insurance policy” for borrowers than placing a cap on student- loan interest rates, said Carmel Martin, who at the time was the U.S. Department of Education’s assistant secretary for planning, evaluation, and policy development in an April 10 conference call with reporters. “In order to have a cap, we would have to charge students more in order to hedge against the possibility that rates would go up to unmanageable levels in the future,” she explained.

But Lauren Asher, the president of the Institute for College Access and Success, which works on college-access issues, said that income-based repayment plans are “no substitute” for a cap on student loans.

An interest-rate formula like the one the president is proposing could ultimately hinder college access, Ms. Asher said. According to recent projections by the Congressional Budget Office, interest on the 10-year Treasury note could rise to roughly 5 percent by fiscal 2017.

And under the president’s proposal, the federal government would add an additional percentage for different types of loans, including 0.93 percent for subsidized Stafford Loans, which tend to help low- and moderate-income borrowers and 2.93 percent for unsubsidized Stafford Loans, another type of federally backed loan for students. That means some students could be paying about 8 percent in interest rates in just a few short years, Ms. Asher said.

But others argued that it’s tough to gauge how big a role interest rates play when it comes to college access.

“There’s not much evidence that [college] choices are being made by people acting as human spreadsheets,” said Kevin Carey, the director of the education policy program at the New America Foundation, a think tank in Washington. Student loans are different from, for example, car loans, for which borrowers are typically able to figure out exactly what their monthly payment will be before they make the purchase, he explained.

And, Mr. Carey added, the administration’s plan to pair the market-tethered interest rate with a “very generous” income-based repayment program has “a lot of merit” because the repayment plan “accomplishes the policy goal that subsidized interest rates had accomplished in the past,” namely, keeping loans affordable.

This isn’t the first time that Congress and the administration have had to cope with an interest-rate jump. Student-loan rates were scheduled to double last summer from 3.4 percent to 6.8 percent, and the issue became a part of the presidential campaign when both President Obama and Mitt Romney, the then presumptive Republican nominee, came out in favor of keeping the lower rate.

Congress passed legislation to leave the 3.4 percent rate in place for one year, mostly as part of an election-year stopgap measure.

K-12 Connection

Meanwhile, the president’s budget would also include a slight boost for Pell Grants, which help low-income students attend college. The proposal would increase the maximum Pell award by $140, from $5,645 in award year 2013-14 to $5,785 in award year 2014-15.

The administration would also seek to prod colleges to hold down the cost of tuition, while improving outcomes for students, by creating a $1 billion edition of its Race to the Top franchise, specifically aimed at higher education. The program would reward up to 10 states that keep tuition increases in check while improving student outcomes, such as graduation rates, and experimenting with new ways of delivering content to students.

The competition also would include something for K-12: States would be rewarded for smoothing the transition between high school and college.

A version of this article appeared in the April 24, 2013 edition of Education Week as Obama’s Proposed Fix on Student Loans Ruffles Allies

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