Policymakers Debate Student Loan Interest Hike

Published May 3, 2012

Interest rates on certain federally subsidized student loans are set to double from 3.4 to 6.8 percent when a five-year amnesty expires on July 1. President Obama is touring campuses to insist Congress extend the lower rate. Likely Republican presidential nominee Mitt Romney also called for the rate extension.

The increase comes as half of recent college graduates are “either jobless or underemployed,” according to the Associated Press.

The Obama administration argues that the hike would increase the cost of a Stafford loan by $1,000. The Congressional Budget Office estimates that keeping the rates artificially low will cost taxpayers nearly $6 billion.

As a result, Congress is debating whether students should pay more for school loans, or whether taxpayers should further subsidize higher education.

On April 27, the House of Representatives passed 215–195 a bill that would maintain the lower interest rates for another year, “paid for” through reallocating funding previously earmarked for parts of the 2010 healthcare overhaul. The Senate is now considering the bill.

Little Benefit to Students
Besides costing taxpayers another $6 billion, artificially keeping the rate down wouldn’t  benefit existing borrowers or reduce the long-run cost of college, said former Congressional Budget Office head Douglas Holtz-Eakin.

The bill’s provisions would apply only to new borrowers, and would reduce average monthly payments by only $7 per loan, he said.

“Those college graduates without work or who are underemployed are likely to struggle to make their debt payment regardless of the interest rate,” said Daniel Bennett, a research fellow at the Center for College Affordability and Productivity. He pointed out there are options for struggling borrowers, such as deferment and income-based repayment.

By subsidizing college loans, the government incentivizes colleges to raise tuition costs to the new, higher level students can now afford to pay, observed Neal McCluskey, associate director of the Cato Institute’s Center for Educational Freedom.

If the rates are allowed to increase, “students will lose some incentive to pay higher prices, and colleges will therefore lose some ability to charge higher rates,” McCluskey said.

Distorting the Labor Market
Few analysts have examined the impact of the Obama administration’s goal for the United States to have the world’s highest proportion of college graduates per capita by the year 2020, Bennett said.

Since the government has a near-monopoly on student loans, its faulty lending practices radically distort the labor market for college graduates, he argued.

“The great surge in college graduates at this point has not been matched by a surge in demand for graduates from the labor market. We have more college graduates than ever before, but we also have more college educated bartenders, lawn care professionals and retail personnel than ever before,” Bennett said.  

Bad Debt and Defaults
In a normal loan market, “lenders…are disciplined by the market, forced to evaluate the risk of their borrowers and price loans based on the potential for repayment,” Bennett explained. “Government student lending does neither, effectively doling out loans to anyone capable of filling out an application.”

Stafford loans go largely to middle-class families, not poor students like Pell Grants, and are an entitlement the government should discontinue given our astonishingly poor fiscal outlook, said Rick Hess, education studies director for the American Enterprise Institute. The program distorts the education market, McCluskey agreed.

“Loans go out to millions of people with no demonstrated ability to handle college work, and at interest rates far below what lenders who can’t pawn losses off on taxpayers would charge,” he said.

When interest rates and the barriers to entering college are artificially low, students will be tempted to take out loans they have no means of repaying, and taxpayers will be on the hook for them, Bennett said.

Nearly 1 in 10 student borrowers default on their loans.

“Rates are doubling specifically because in 2007 Congress passed – and President Bush signed – legislation temporarily cutting them in half. That predated President Obama, but Washington has dominated student lending for decades,” McCluskey stated. “And the sudden doubling? That’s what you get from politicians, who naturally make decisions based on political—not educational or financial—calculations.” 

Image by jjinsf94115.