When trying to understand a confusing topic like student loans, it helps to talk it through with someone—so that’s what we did. Today, compliance (i.e., student loan) expert Ashley tries to do the impossible: make student loan interest rates, well, interesting. You should care if you’re going to borrow new loans soon—these changes could cost you.
On July 1, Stafford loan interest rates are set to double from 3.4% to 6.8%. I’ll give you a moment to let that sink in.
You might wonder why the government is raising the interest rate on struggling students in what, some say, is a struggling economy. They aren’t actually. They’re trying to lower it.
Let me explain. Get ready for an economics lesson.
The Tumultuous History
Federal student loan rates (Stafford loans) were not always as low as they are now. In fact, they were more than double the current rate in the ‘90s.
|Year||Rate||Undergrad Stafford Loan Formula|
|2005-06||5.30%||Variable rate, cap 8.25%|
|2004-05||3.37%||Variable rate, cap 8.25%|
|2003-04||3.42%||Variable rate, cap 8.25%|
|2002-03||4.06%||Variable rate, cap 8.25%|
|2001-02||5.99%||Variable rate, cap 8.25%|
|2000-01||8.19%||Variable rate, cap 8.25%|
|1999-00||6.92%||Variable rate, cap 8.25%|
|1995-98||8.25%||Variable rate, cap 8.25%|
|1994-95||7.43%||Variable rate, cap 8.25%|
So, What Happened?
In 1992, variable rates were introduced, and from ‘92 to ’00, rates fluctuated from 6.22% to 8.25%. No one who went to school during the ‘90s had interest rates as low as they are now. (A little consolation, right?)
Why was this? The economy was booming, and when the economy is doing well, it costs more to borrow. When the economy isn’t doing well, it costs less to borrow because the government wants to encourage growth. To learn more, register for Macroeconomics 101.
The 2000s not only brought Apple stores, The Office, Mad Men, and CSI, but they also introduced our current era of student loan debt awareness. More and more students entered college, borrowing more and more to do so. Students didn’t want the uncertainty of variable rates, so rates were permanently fixed at 6.8% in 2006 (right around the current market rate).
Of course, “permanently” lasted only 2 years, as temporary legislation changed the rate to take advantage of super-low rates.
A Temporary Reduction
In 2008, Congress launched a campaign to cut student loan interest rates in half, which they sort of did. They temporarily reduced subsidized Stafford loan rates annually for 4 years (from 6% to 5.6% to 4.5% to to 3.4%) until July 1, 2012, when the rates would go back to 6.8% to match the unsubsidized Stafford loan rates. (Unsubsidized Stafford loans have been 6.8% since 2006.) They did this anticipating the rates would return to the previous levels from pre-’08.
Of course, they didn’t.
Last year, student loan debt surpassed the $1 trillion mark, and lowering the interest rates became a priority. After a lot of partisan quibbling, both sides came to an agreement that kept the 3.4% interest rate for 1 year.
Plans Of Action
So, here we are in 2013, and the rates are set to double again. What’s being done? A lot, actually. Congress and the White House agree this problem needs to be resolved, but not everyone agrees on how to fix it.
Here is a quick breakdown of some of the proposals out there (as of today):
|Whose Plan Is It?||How Is It Calculated?||2013-2014 Rates?||For How Long?|
|President||Variable: tied to the 10-year Treasury note with no maximum rate, but would be fixed in repayment.||For the 13-14 year, the subsidized Stafford loan would be 2.7%, the unsubsidized Stafford would be 3.7%, and PLUS loans would be 4.7%.||All loans made after July 1, 2013.|
|House of Representatives (multiple plans in the works)||Permanently extend current fixed rates.||Subsidized Stafford at 3.4%. Unsubsidized Stafford and PLUS loans at 6.8%.||All loans made after July 1 2013.|
|Extend current fixed rates for one year.||Subsidized Stafford at 3.4%. Unsubsidized Stafford and PLUS loans at 6.8%.||All loans made from July 1, 2013, to June 30, 2014.|
|Set all rates to 3.4%.||3.4%.||All loans made after July 1, 2013.|
|Senate||Variable: tied to the 10-year Treasury note with no maximum rate.||For the 2013-14 year, all federal student loans would be 4.7%.||All loans made after July 1, 2013.|
This isn’t all the bills; in fact, three more were introduced as I was writing this. Still, this should give you a general picture of the ideas bouncing around D.C.
What This Means For You
There are pros and cons to each proposal, but I think things will go one of two ways. Either they settle on a variable rate system with a cap or they fix the rates at the current 3.4%.
If interest rates become variable with a cap, then the rates will change annually. They’ll be low when the economy struggles and higher when the economy does well. The cap will keep the rates from getting too high for comfort.
The fixed rate of 3.4% seems like a deal, but it may not always be. It all depends on what the Treasury bill rates are set at each year. Unfortunately, I don’t have an interest rate crystal ball to predict when the variable rate may be lower than the fixed one.
Another problem that Congress has to deal with is the cost of lowering or extending the current interest rate. Extend the 3.4% for a year, and it will cost the taxpayers $6 billion. Keep rates at the current level or lower them, and that may mean removing student loan subsidies or increasing origination fees—making borrowing more expensive in other ways.
This is why fixing the interest rate problem isn’t an easy thing to do.
Load your loan info into SALT™ to calculate how the various interest rate proposals would affect your loans