WASHINGTON – An interest rate hike on student loans will likely come into effect Monday after negotiations between a bipartisan group of senators and Democratic leadership collapsed last week.
Interest rates are set to double July 1, from 3.4 percent to 6.8 percent, for more than 7.4 million students with federal Stafford loans.
The Senate adjourned Thursday night for the July 4 recess without approving a student loan rate package.
With tuition costs climbing, Congress agreed in 2007 to give students a better deal on government-backed loans. Instead of adjusting interest rates every year to reflect the interest rate on government bonds, they fixed the rate at 6.8 percent. And for lower-income students qualifying for subsidized loans, Congress lowered the rate gradually to a rate of 3.4 percent. But to reduce the program’s cost, the interest-rate cut only applied to loans originated before June 30, 2012.
The federal government subsidizes these loans by relieving the borrower of interest rate obligations that accrue while the student is in school and during other authorized periods.
A group of bipartisan senators, including Sens. Joe Manchin (D-W.Va.), Richard Burr (R-N.C.), Tom Coburn (R-Okla.), Lamar Alexander (R-Tenn.), and Angus King (I-Maine), introduced a plan Thursday that would lower and fix interest rates for 100 percent of newly issued student loans. Their bill would base interest rates on the 10-year Treasury note plus an added 1.85 percent, which would put current rates at 3.66 percent. All loans would be capped at 8.25 percent, slightly below the 8.5 percent cap included in the House bill. The Senate proposal would also lock interest rates for the life of the loan.
“This compromise will allow market forces to help students pay for college. Students and families should not have to be held in limbo while waiting for Congress to set yet another arbitrary rate. This compromise is a permanent solution that will benefit virtually all borrowers and taxpayers. This bill allows borrowers to take advantage of today’s low rates while protecting taxpayers from subsidizing artificial rates,” Coburn said.
Meanwhile, Sens. Sherrod Brown (D-Ohio) and Heidi Heitkamp (D-N.D.) announced a proposal Tuesday that would make it easier for people to refinance private student loans.
“Why should our students and graduates be the last to benefit from historically low interest rates?” Brown said. “Helping graduates refinance their private student loan debt into more affordable terms frees up funds for them to buy houses, start businesses, or contribute to their communities. It makes sense for our students and graduates and it makes sense for our economy.”
Approximately 85 percent of student loans are federal loans. Federal loans offer greater relief to borrowers than private lenders when facing financial hardship. Federal loans also allow for an income based repayment plan related to a borrower’s income and family size.
As a result, federal regulators and some lawmakers called on private student loan lenders to offer more flexible repayment terms to borrowers at a hearing held by the Senate Banking Committee on Wednesday examining the private student loan industry.
“It’s absolutely important that we address the large population of existing private loan borrowers. Many of those borrowers are certainly victims of the bad economy that they had no role in creating,” Rohit Chopra, student loan ombudsman at the Consumer Financial Protection Bureau (CFPB), told the Senate panel.
The rate increase would not affect existing loans and would apply only to new loans originating after July 1. They would affect about a third of all undergraduate students who rely on subsidized loans.
This change will likely result in borrowers moving from government subsidized loans to private sector loans, said Todd Vermilyea, senior associate director with the Federal Reserve’s banking regulation division.
Vermilyea said balances of student loan debt are now greater than any other consumer loan product with the exception of residential mortgages. In a slow economy dependent upon young borrowers to spend money throughout their lifetimes, the rate increase in student debt could mean prolonged economic stagnation because young people would reduce their other debt obligations, including credit card, auto, and mortgage debt.
Although private student loans make up only a small portion of total student debt, federal regulators said many people are struggling to repay their private loans.
Doreen Eberley, director of risk management supervision at the Federal Deposit Insurance Corporation (FDIC), told the panel that as of 2011 the size of the private student loan market amounted to about 15 percent of all student loans outstanding. In the 2011-2012 academic year, banks supervised by the FDIC held about $14 billion in private student loans and lent approximately $4 billion in new loans.
President Obama and House Republicans have proposed similar ways of tying student loan rates to 10-year Treasury bills. Nevertheless, the two sides disagree on the details. The White House wants to allow more borrowers to defer payments and not make payments in full. Under the House bill, federal student loan rates would be set at the 10-year Treasury note plus 2.5 percent. The rate would be variable and reset each year. Unlike the House GOP plan, Obama proposed to guarantee a fixed rate for the life of the loan.
Obama said he would veto the House bill if it were to pass in the Senate, saying the legislation “isn’t smart, and isn’t fair.”
With the Senate’s attention focused on the effort to pass a comprehensive immigration bill before Congress left for a weeklong recess, the chances of a quick fix to the student loan interest rate hike seemed bleak even before senators reached a final impasse on Thursday.
“We probably can’t get anything done this week,” said Sen. Tom Harkin (D-Iowa). “We’re working on it, but there has been no agreement so far.”
Alexander and Sen. John Thune (R-S.D.) also downplayed the significance of the deadline, saying lawmakers could return to Washington after the break and deal with the issue retroactively.
Democrats said the Senate would vote on July 10 on a one-year extension of the current interest rates.
A spokesman for Senate Majority Leader Harry Reid (D-Nev.) indicated Wednesday that any bill that ties rates to the 10-year Treasury note had no chance of passing the Senate.
“There is no deal on student loans that can pass the Senate because Republicans continue to insist that we reduce the deficit on the backs of students and middle-class families, instead of closing tax loopholes for the wealthiest Americans and big corporations,” Reid’s spokesman Adam Jentleson said. “Democrats continue to work in good faith to reach a compromise, but Republicans refuse to give on this critical point.”
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