Not a Reason to Raise Student Loan Interest Rates

Earlier this month, the Federal Education Budget Project (FEBP) released an issue brief, Federal Student Loan Interest Rates: History, Subsidies, and Cost, meant to provide context to the debate over an increase in the interest rate charged on a subset of federal student loans schedule to occur this year. Without congressional action, interest rates on Subsidized Stafford loans for undergraduates issued for the 2012-13 school year will increase from 3.4 percent to 6.8 percent. President Obama wants to postpone the increase, letting borrowers take out loans at 3.4 percent for one more year. Some lawmakers have introduced legislation that would permanently set the rate at 3.4 percent for all Subsidized Stafford loans issued to undergraduates in the future.  

The issue brief explains the series of events that led Congress to set the current fixed rates and why rates on loans issued later this year will double. It also provides a framework for assessing the budgetary costs of the federal student loan program and explains that the student loan programs provide subsidies to borrowers – even at current interest rates – that come at a cost to taxpayers.

A number of advocates have interpreted the FEBP issue brief as an argument in favor of increasing student loan interest rates. It is emphatically not.

It appears that some readers have jumped to that conclusion because the issue brief explains that the interest rates charged on federal student loans do not fully offset the cost of loan program. However, the issue brief does not argue that the rate should fully cover the costs; it argues the opposite. If Congress charged an interest rate on federal student loans that fully offset the costs of the program, the program would not provide any value or benefit to borrowers. In fact, the federal government makes student loans explicitly to provide students with benefits they could not find in the private loan market. And we believe strongly in this mission.

That’s why it is baffling to us that the some have interpreted the paper to conclude that “the government needs protection from defaulting borrowers, and that rates should return to higher levels.” Or as another source incorrectly claims, the FEBP paper argues “we should let the rates go up… [because] taxpayers need to be compensated for their risks.”

Excerpts from the paper contradict these statements:

To be sure, policymakers could set an interest rate high enough to more than offset the costs listed above, [defaults, etc.] but such a rate is likely to provide little value over the rates that private lenders offer and would undermine the goals of the program…

…[interest] rates may indeed be too high relative to some borrowers’ abilities to repay or according to those who believe the federal government ought to increase subsidies for higher education. Those measures, however, concern the degree to which the federal government subsidizes student loans, not whether the current terms offer any subsidy at all. On the latter measure, current interest rates are in fact set low enough to subsidize borrowers and impose costs on the federal government.

…While the federal government is not a profit-making entity, it does incur costs when borrowers default or become delinquent on their loans. Like private banks, the interest rate the government charges in excess of what it pays to borrow helps offset the costs associated with defaults, though it need not offset 100 percent of these costs.

…That finding [the program subsidizes borrowers at a cost to the government], however, should not be viewed as a negative judgment on the program. On the contrary, the purpose of the federal student loan program is to provide subsidized credit to the vast majority of students who would be unable to borrow to pay for their education in the absence of such a federal program.

It is possible that those who mischaracterized the FEBP issue brief didn’t read the entire report, or relied on others’ interpretations of the report rather than drawing their own conclusions. We were careful in the report to make clear that we were not making the case for higher student loan interest rates. In fact, the paper does not address the issue of what interest rates should be. Instead, it provides historical and budget context to the debate over student loan interest rates.

Hopefully, those interested in the federal student loan policy will read the entire report and resist the urge to see it as an argument for higher or lower student loan interest rates. The forthcoming debate about increasing interest rates is likely to be complicated and stakeholders should be as informed about the nuances as possible.