Consumer Comeback Blog

Student loan interest rates may be going up – what you should know

It certainly feels like this sometimes...

Bad news for students borrowing for college this past week:

The Senate failed Tuesday to advance a bill to keep federally subsidized college student loan rates lower for another year, prolonging debate on an issue that has emerged as an election-year flashpoint

Student loan interest rates for federally subsidized Stafford loans may as much as double, to 6.8%, this summer. The rate has been lowered since 2007 as a way to ease the burden of student loans. The failure of an extension of this part of the program is

While the rate probably seems high, the reality is, it may not be quite as bad as it sounds. The average additional cost per student (over a 10 year payment plan) would be about $2,600 or approximately $28 per month. But, of course, students need all the help they can get these days. So regardless of how objectively bad the reality is, it’s a step in the wrong direction for today’s students.

What the political debate is about

The debate isn’t about whether or not to extend the lower interest rate…both sides agree that it’s a good idea. The debate is how the extension is to be pay for it. According to the Washington Times article:

A House Republican plan approved in late April would pay for the lower rates by cutting almost $6 billion from a preventative health-care fund established in the Democrats’ health care reform bill.

Democrats pushed a plan to pay for the extension by ending a tax break that allows operators of some businesses with three or fewer shareholders to avoid paying payroll taxes by labeling some of their income as business profits rather than wages.

And now, the issue is being used as a part of the political posturing/blame game, with students caught in the middle.

Why student loan interest rates are so high

Because prospective students have little to no credit history, interest rates aren’t a reflection of the individual student’s responsibility with debt (credit score, etc.). Also, unlike other kinds of loans, interest rates don’t vary based on how much an individual borrows. Instead, student loan interest rates a reflection of the pooled risk among all student loan borrowing.

Two major factors are involved:

  1. How much overall student loan debt (yearly demand)
  2. The average estimated time of payback

The second factor is certainly affected by the first, but is additionally influenced by the overall job market for students who borrowed.

The main reasons student loan interest is currently so high is because overall student debt is at historic levels, driven by rapidly rising costs of education; and the job market is extremely weak, driven by poor economic recovery. Not just high unemployment, but also low salaries.

So while extending the low interest rates is probably the right thing to do for students, the discussion of how to pay for it should include a focus on ways to reduce the rates naturally. This means a focus on job creation for new graduates as well as ways to keep the costs of education under control. Not just to make paying loans back easier, but ways to reduce the demand for student debt in the first place.

What this all means for students

If the government doesn’t find a way to extend the low interest rates, next year’s students will be the ones that take the hit. Interest rates for past loans won’t change, but any new loans will be set at a higher rate. So what does this mean for students, exactly? Here’s the rub:

The maximum Stafford loan amount (for a 5 year degree) is $24,500. If it took the maximum 25 years to pay off, the higher interest rate could cost a student as much as $14,600 or about $50/month in additional interest payments. This is the worst case scenario.

If the high costs of education wasn’t enough of a wake-up call to students, the prospect of paying high interest rates should be. It’s an indication that college graduates are having an increasingly difficult time paying off their debt, so prospective students need to start taking it more seriously.  Here’s some advice for potential and current students:

  • Know what you’re getting into: keep track of the amount and interest rates for all loans and understand what you will will owe overall when you graduate.
  • Reduce dependence on borrowing by:
    • Choosing less expensive programs/schools (state school, community college, etc.)
    • Save for school, work summers & throughout school and pay more tuition up-front
    • Pay off loans quicker after graduation
  • Take job prospecting & school more seriously
    • Get hands-on work experience BEFORE you graduate
    • Work with career centers & academic advisers/mentors
    • Consider career options before entering college (especially if you are borrowing)