The Student Loan Battle Continues -- and Neither Side Offers a Great Deal

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President Obama
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On Friday, President Obama once again took aim at the student loan crisis, accusing congressional Republicans of pushing a plan that would make college more expensive and, potentially, take it out of the reach of many lower-income students.

The battle over student loan rates -- which the president noted is now in its second year -- in many ways boils down to a question of economic responsibility. Currently, Congress sets the rate on federal student loans. If it raises the rates, loans become more expensive and, presumably, many students will opt out of going to college. If Congress lowers the rate, loans become less expensive and students will be more likely to stay in school. Both Congress and the president have offered proposals that would take this responsibility out of their hands, putting it on the market.

Different Proposals

As those of us who went to school from the early 1990s through the mid-2000s can remember, student loan rates were once tied to U.S. Treasury bonds. When the interest rates on bonds rose and fell, loan interest rates followed suit. On the bright side, there was a cap, or limit, to how high the rates could go. Unfortunately, that cap was high -- for a time, it topped out at 9 percent. By comparison, student loan rates currently range from 3.4 percent (for subsidized Stafford loans) to 7.9 percent (for PLUS loans).

Congress and the president are both proposing new guidelines that would tie the interest rate to the economy. Under the president's proposal, 10-year Treasury notes would be the benchmark for loan interest. The interest rate on subsidized Stafford loans would be the Treasury note rate plus 0.93 percent; on unsubsidized Stafford loans, it would be Treasury rate plus 2.93 percent; and on loans to grad students and parents, it would be Treasury plus 3.93 percent.

Today, the Obama proposal would be a considerable benefit to students. It would lower the subsidized Stafford loan rate by 0.65 percent, the unsubsidized Stafford rate by 2.05 percent and the grad rate by 1.05 percent. The trouble is that the Treasury note interest rate is currently near historic lows and is almost certain to rise if the economic rally ever kicks into gear. As The Atlantic noted, there are times during the past few decades when -- under the proposed plan -- student loan interest rates would have jumped above 12 percent.

And, because, the president's plan also doesn't put a cap on interest rates, there would theoretically be no limit to how much students could end up paying.

The Congressional Plan

On the bright side, Congress' plan puts a cap on interest rates: For subsidized loans, students couldn't end up paying more than 8.5 percent; on unsubsidized loans, it couldn't be more than 10.5 percent. And while these rates are quite high, they are still lower than the potential rates that students could be stuck with under Obama's proposal.

But when it comes to the minimum rate, the Congressional plan falls down. Currently, the interest rate is determined when the loan is issued, which means that students borrowing money can count on a consistent rate for the life of their loans. Under the Congressional proposal, federal student loans would be variable rate, which means that the percentage that students would have to pay would fluctuate with the economy.

Rating the Proposals

Put another way, the rate issue boils down to an Obama plan, which would establish loan rates that could theoretically be extremely high but would not change during the duration of the loan. Congress, on the other hand, would establish rates that would be limited, but could go up or down, depending on the vagaries of the economy.

This variable rate could have an upside: When the economy is doing well and hiring is strong, rates would likely rise; conversely, when the economy is sluggish, rates would fall. For borrowers, this could translate into lower rates during hard times and higher rates during boom cycles.

By comparison, the current method, which establishes firm rates, is not responsive to economic ups and downs. Because of this, students who attend school during economic boom times but have to repay their loans during economic busts can easily find themselves trying to service high-rate loans at the worst possible times. This, incidentally, is a big part of the problem now: Many students who took out loans at 8 percent or higher during the 1990s and 2000s are in repayment mode when interest rates are low and hiring is sluggish.

Payback Is (But Doesn't Have to Be) Hell

But if Obama's loan rate plan is potentially problematic, his payback plan is very promising. Pay As You Earn, the president's first stab at the student loan issue, was designed to ensure that students could not become enslaved by crushing loan debt. Instituted last year, the program caps student loan repayment levels at 10 percent of the borrower's discretionary income, effectively ensuring that recent graduates won't get stuck with brutal monthly payments. At the same time, the program also places an effective limit on the length of repayment: After a student has been paying off their debt for 20 years, the program will retire any debt that remains.

It's a great idea, and could go a long way toward ending the student loan debt carousel that so many workers are stuck on. Unfortunately, there are some rather severe caveats. To begin with, Pay As You Earn is only available to students who have taken out at least one student loan after fiscal year 2011. In other words, most people who are already in repayment hell are stuck there.

Also, the program only applies to federally backed student loans, which means that many people struggling under the worst loan debt -- those who took out higher-interest private loans -- are ineligible.

Ultimately, the student loan issue bleeds across the economy, with ripples that go far beyond recent grads. As Obama noted in Friday's speech, high student loan debt translates into lowered economic activity. As students struggle to pay their loans, they often aren't able to afford to buy cars and houses and other consumer goods that would help boost the economy. With that in mind, the goal, ultimately, must be to make loan payments a reasonable and affordable part of a graduate's budget, not a crushing burden that makes other expenses impossible. Under that rubric, however, both Obama and Congress' plans are a failure.

Bruce Watson is DailyFinance's Savings editor. You can reach him by e-mail at bruce.watson@teamaol.com, or follow him on Twitter at @bruce1971.

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27 Comments

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Alan

We need more STEM graduates. For us to fill jobs these degrees can fulfill with H1B visa holders is crazy, against our national interest, and damages our economy every year we allow it to continue. The solution is low cost- no cost loans for these curricula and more scholarships. This cost shifting to students puts the US at a huge disadvantage that will, over time, severely damage our economy and limit our economic future.

June 03 2013 at 4:24 PM Report abuse rate up rate down Reply
1 reply to Alan's comment
theycallmeroy3

Man Allen, I'll tell you, I use it buy into that too. Until... a stem graduate by the name of Walter Hickey wrote a compelling piece just recently titled : The Real Truth about Stem Shortages That Americans Don't Want to Hear. It'll just mess you up when you read it.
Hickey comes with charts and up in your face studies... that will just...mess you up.
I'll give a little preview.
Hickey brilliantly argues, that America doesn't have a STEM shortage at all, but more to the point that Silicon Valley just doesn't want to hire them. Instead they want to draw from a much larger pool of immigrants, who will work longer and for less pay. And to add insult to injury, suggest that even the American graduates in STEM at the very top schools, are still not good enough. On the net-worth the read.

June 03 2013 at 6:54 PM Report abuse rate up rate down Reply
nedfarn25

how about lyin lizzie warren and her isolated bretheren in academia take a pay cut--lizzie made 350,000 for a one hour a week class. something should be done to help-there are many options that could all be brought together

June 03 2013 at 4:21 PM Report abuse rate up rate down Reply
joannecdsnj

Why is it that the 1% can get loans for 1 to 2% but college students have to pay 6%?

June 03 2013 at 3:39 PM Report abuse -1 rate up rate down Reply
1 reply to joannecdsnj's comment
h.hughjardon

Why is it that tuition has nearly tripled in the last 30 years or so?

June 03 2013 at 8:52 PM Report abuse rate up rate down Reply
h.hughjardon

Is barry telling these kids,

" You thnk your student debt is bad now, wait until you realize that each and everyone one of you is beii g strapped with an additional $50,000 for your share of the national debt. "

June 03 2013 at 3:31 PM Report abuse -1 rate up rate down Reply
aevf101

The college loan program is broken. Been broken for awhile, over several administrations. Had a bunch of duct tape and band aids plastered all over it and the system has muddled along. Obama and everyone concerned needs to stop pointing fingers and playing the blame game and focus all their collective energy into fixing the problem. Can anyone come up with one good reason why politics needs to play into this situation?

June 03 2013 at 2:51 PM Report abuse +2 rate up rate down Reply
1 reply to aevf101's comment
h.hughjardon

The college tuition is what's making people go broke...why is tuition soooooo damned expensive?

June 03 2013 at 3:04 PM Report abuse -1 rate up rate down Reply
whackobachmann

WANTED,.......a tea party Queen to take my position.

Yours truly, Michele Whackobachmann..........

June 03 2013 at 2:31 PM Report abuse -2 rate up rate down Reply
1 reply to whackobachmann's comment
h.hughjardon

Wanted: a drag queen for spongebob barthold's mom's basement.

June 03 2013 at 3:20 PM Report abuse +2 rate up rate down Reply
whackobachmann

WANTED,.......a tea party Queen to take my position.

Yours truly, Michele Whackobachmann..........

June 03 2013 at 2:31 PM Report abuse -1 rate up rate down Reply
whackobachmann

WANTED,.......a tea party Queen to take my position.

Yours truly, Michele Whackobachmann..........

June 03 2013 at 2:31 PM Report abuse -1 rate up rate down Reply
dbaker97

how about don't take on an excessive amount of student loan debt. most students are using funds from loans to rent condos, buy cars, party, etc. they also need to take classes in personal finance and money management. they should know how to amortize a loan. taking anywhere near 20 years to pay student loans is insane as is the 10 percent of disposable income. loans should be made direct from government to student at a low rate of maybe 4-5 percent and disburse funds only for tuition and books.

June 03 2013 at 1:24 PM Report abuse rate up rate down Reply
rich_paddlyrich

obamy.failed.again

YEA OBAMY N HIS FAT AMERICAN HATING WIFE ARE BOTH STUCK ON STUPID N THEIR PRESENCE N INCOMPETENCE N STUPIDITY TANKED OUR ECONOMY N HOUSING MARKETS~~> NO JOBS N NOTHING BUT "BENGHAZI"~"BENGHAZI"~"BENGHAZI"~N SPYING O N THE AMERICAN PEOPLE . !

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h.hughjardon

WTF does that have to do with student loan interest rates spongebob?

June 03 2013 at 12:55 PM Report abuse +4 rate up rate down Reply