The Student Loan “Crisis” In Context

I’ve been doing some long-over-due cleaning out of old files and papers the past week or so (call it the flooded-basement stimulus program). Among the documents I rediscovered were my student loan payment records. (You’d think that etched stone tablet would be hard to miss, right?) Yes, I did actually pay off my student loans–ahead of time, even. But what struck me was the interest rate I was charged on my subsidized federal student loans: a whopping 8%.

It got me wondering about the current “crisis” over student loan interest rates, which yesterday jumped to a fixed 6.8% (from 3.4%) for most subsidized loans in the coming school year, and how this new rate compared to historical student loan interest rates. A quick look at FinAid.org‘s report of historical student loan rates is very revealing:

  1. 6.8% is the fixed rate that Congress had originally approved for the 2006-07 and 07-08 academic years, before Congress started cutting it down to the recent fixed 3.4% rate. So the jump essentially restores the pre-recessionary interest rates.
  2. Prior to 2006, subsidized student loan rates were substantially lower, but were adjustable-rates, not fixed. Congress set the fixed rate for 2006-07 because the adjustable rate formula was resulting in higher interest rates that year (7.14% in 06-07 and 7.22% in 07-08). Congress apparently foresaw a future of higher interest rates, making a fixed 6.8% seem like a deal. Nice job, Congress!
  3. But then a funny thing happened on the way through the recession–all those adjustable rate loans from pre-2006 suddenly got a lot cheaper as Bernanke and gang pushed interest rates down. Just when Congress thought they “fixed” the student loan problem by fixing interest rates, they instead cost students (and taxpayers) millions of dollars in extra interest payments (or loan defaults, in the case of taxpayers). Students paying on loans made prior to July 2006 paid only 2.47% interest in 2010-11 compared to 4.5% for loans made that year….or 6.8% for loans made in 2006-08. FinAid doesn’t have numbers up for 2011-12, but given where interest rates have been it is a safe bet that the adjustable rate was still below the 3.4% for loans made that year. Nice job, Congress!

And therein lies the heart of the current debate: Continue reading The Student Loan “Crisis” In Context

Misguided Student Loan “Solutions”

ABC News is reporting that Congress is set to take up a student loan fix, but it’s difficult to fix a problem you have yet to define–much less understand. But when has that ever stopped Congress before?

What is the “student loan problem” to be fixed? The immediate issue is that the interest rate for new federally subsidized loans is set to double on July 1, from 3.4% to 6.8%. Republicans are offering a plan that would keep rates from going up as much in the short-term, but could potentially increase several years down the road (assuming Congress wouldn’t step in to stop it then…as they’re trying to now). Democrats, on the other hand, simply want to extend the current 3.4% rate…ostensibly for just two years, while working on a long-term fix (a familiar tune). Democrats believe that, by keeping the price of student loans artificially low, they are helping the average person or family better afford college.

And this is the point where economic reality (and the real student loan problem) is promptly ignored. Continue reading Misguided Student Loan “Solutions”

The Real Problem With Student Loans

Suppose you want to make an investment in a long-term asset that pays off over the next 45 years. You go to the bank and ask for a loan to pay the up-front cost of the investment with the promise to pay the funds back once the asset begins paying returns.  The bank offers to loan you the funds at an interest rate of X% that reflects the risk-adjusted cost of making the loan based on the riskiness of the asset and your likelihood of repayment.

In any normal context, you would look at the interest rate, look at the expected payoff of the investment, and determine whether or not the investment still made sense given the cost of borrowing the money. If the cost of the loan to make the investment was higher than the expected payoff, then you would either seek a cheaper loan or you would forgo the investment.

That is, unless it’s a student loan. And THAT is why we have a student debt problem. Continue reading The Real Problem With Student Loans