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Two weeks ago Ed Money Watch explained an alternative to the one-year extension of the 3.4 percent interest rate on newly-issued Subsidized Stafford loans for undergraduates pending in Congress. It would peg fixed rates on all new federal student loans to the 10-year Treasury rate plus 3.0 percentage points in the year the loans are issued. While the Congressional Budget Office says that extending the 3.4 percent interest rate on Subsidized Stafford loans by one year will cost $6 billion, this alternative proposal cuts spending by $52 billion. How have lawmakers and student aid advocates responded to this proposal? With deafening silence.

Policymakers and advocates think this proposal isn’t politically viable or beneficial for borrowers because it would set fixed rates on Subsidized Stafford loans issued this year at 4.75 percent for the upcoming school year (based on the May 21, 2012 rate), which is higher than the current 3.4 percent that may be renewed. If any proposal sets the rate higher, some borrowers will pay more, they say. (The 10-year Treasury note proposal lowers rates for graduate students, too, but we will leave that aside for purposes of the discussion that follows.)

These skeptics obviously haven’t done the math. Nearly all undergraduates who borrow this year would owe less at graduation and pay less monthly under the proposed alternative—even those who are eligible for Subsidized Stafford loans at the 3.4 percent rate under the pending extension.

The table below compares how undergraduates who borrow the maximum amount of Subsidized and Unsubsidized Stafford loans in each year will fare under both interest rate proposals.

Here are a few key points on how the figures were calculated:

Regardless of financial need, all first-year, dependent undergraduates automatically qualify for $5,500 in Unsubsidized Stafford loans at a fixed interest rate of 6.8 percent. Within that limit, however, a borrower may qualify for up to a $3,500 Subsidized Stafford loan (which would carry the 3.4 percent interest rate) if he meets a needs analysis test. If a borrower qualifies for that maximum, then he has two loans: one loan of $3,500 at the 3.4 percent rate and another of $2,000 at the 6.8 percent rate within the $5,500 limit. The breakdown is a bit different for each year a borrower is enrolled, and many borrowers qualify for less than the $3,500 in Subsidized Stafford loans because eligibility is based on a sliding scale.

Additionally, under current law, Unsubsidized Stafford loans accrue interest annually while a borrower is in school. No interest accrues on Subsidized Stafford loans during that time. As a result, a student’s loan balance at graduation is not just the sum of their Subsidized and Unsubsidized Stafford loans, but the sum of their loans plus accrued interest. Thus, we calculate the weighted average interest rate for each year a student borrows based on the share of the student’s total loan balance at graduation that is Subsidized (3.4 percent interest) and Unsubsidized (6.8 percent interest).

In contrast, the 10-year Treasury note proposal Ed Money Watch discussed earlier would set the same fixed interest rate for both loan types. As a result, no weighted average annual interest rate applies.

Due to the higher interest rate on Unsubsidized Stafford loans under the pending one-year extension of the 3.4 percent interest rate for Subsidized Stafford loans, a borrower will actually graduate with a higher loan balance under the 3.4 percent rate proposal than under the 10-year Treasury note proposal. In fact, the higher rate of interest accrual skews the weighted average interest rate under the 3.4 percent rate proposal above 4.75 percent for first year students.

And even though second, third, and fourth year students will pay lower average interest rates on the loans they take out in each year under the 3.4 percent rate proposal, the higher interest rate on the Unsubsidized portion of their loans will result in higher loan balances. In the end, a student that borrows the maximum amount in all four years will actually pay less per month under the 10-year Treasury note proposal than under the 3.4 percent rate proposal.

To be fair, a very small share of students could end up paying a tiny bit more under the 10-year Treasury note proposal (a few dollars a month) for loans they take out this coming school year compared to the 3.4 percent interest rate proposal (e.g. students who borrow Subsidized Stafford loans but forgo the extra Unsubsidized Stafford loans for which they qualify). But many more borrowers—including graduate students—will benefit from the lower rate under the 10-year Treasury note proposal. Some critics will also point out that interest rates on future loans could be higher than 4.75 percent, even higher than 6.8 percent. That is true, but if the concern is that rates might go higher, then borrowers and policymakers may be better off just sticking with the current 6.8 percent.

Finally, some would-be supporters are nervous that President Obama and Democrats in Congress will accuse anyone who supports the 10-year Treasury note proposal instead of the 3.4 percent rate proposal of “raising interest rates on student loans.” If they do, point to this analysis. If they dismiss this analysis, then they are more interested in scoring political points than helping students.

The deadline for sequestration—the automatic, across-the-board spending cuts that were triggered last fall when the “supercommittee” failed to reach a deficit reduction agreement—is drawing near. It takes effect January 2013, part-way through fiscal year 2013. Experts and onlookers have been trying to figure out if and how lawmakers will cancel sequestration before that deadline. The Republican-led House of Representatives now has its answer.

First, a refresher on how Congress got here: As part of an agreement to increase the limit on the national debt last summer, legislators passed the Budget Control Act of 2011, which sets up a framework by which lawmakers are to enact policies to reduce future budget deficits. If they don’t, the law automatically cuts spending through sequestration and sets limits on future appropriations.

Much of the deficit reduction outlined in the law was supposed to come from a bipartisan bill drafted by a joint House-Senate committee, known as the “supercommittee.” Supercommittee members were never able to agree on a bill, triggering the sequestration and spending caps. Unless Congress and the president now agree to override them, the cuts and caps will proceed as outlined in the law. The sequester will automatically cut fiscal year 2013 appropriations by about $93 billion, of which $55 billion comes out of defense programs and $39 billion comes out of non-defense programs. Within those amounts, the cuts will be distributed evenly across all non-exempt programs. (Pell Grants are the only exempt education program.)

Last week, the House passed a bill that, if signed into law, would cancel the sequester that applies to fiscal year 2013 appropriations. The bill includes policies that would reduce spending across a range of non-education programs funded outside the appropriations process. House lawmakers say those cuts would take the place of the automatic spending cuts that would have come through sequestration.

Nevertheless, education programs—nearly all of which are funded through the annual appropriations process—have not yet escaped unscathed in the House-passed bill. The bill leaves in place a cap on total appropriations funding for fiscal year 2013 that the House adopted earlier this year. That cap is $1.028 trillion, $15 billion below the total appropriations level enacted for fiscal year 2012.

The lower spending cap does not guarantee that lawmakers will cut funding for any or all education programs when they finalize fiscal year 2013 appropriations funding (fiscal year 2013 starts October 1, 2012), but education programs will compete with other programs for funding within a smaller pie. Even if the House bill becomes law, Congress must still determine funding levels for education programs during the appropriations process. Thus there is no meaningful way to predict how the House appropriations limit would affect education programs. Moreover, Congress has actually increased total appropriations for Department of Education programs in recent years even when it has cut appropriation funding across all agencies in aggregate.

It should also be noted that the House-passed bill leaves sequestration in place for programs funded outside of the appropriations process, so-called mandatory programs. This won’t mean much for education programs, since almost all are funded through the appropriations process. Some funding for Pell Grants is mandatory, but it is exempt from sequestration by law. That leaves student loans. The sequester would cut funding for student loans by increasing the origination fee borrowers pay when they take out new loans. That increase is likely to be about a half a percentage point, meaning the fee on a $5,000 loan will cost an additional $25.

To be clear, the Senate isn’t likely to take up the House bill. And the Senate shows no signs of adopting an alternative to cancelling the pending sequester.

In other words, if and how Congress will cancel the sequester is still anyone’s guess. Despite the action in the House, a definitive answer isn’t likely until after November elections.

But Jason Delisle, director of the Federal Education Budget Project at the New America Foundation, said programs already are in place to help students who are unemployed or to lower payments based on income. The foundation is a public policy institute ...

While Congress has debated extending the 3.4 percent interest rate on Subsidized Stafford loans issued this year to undergraduates, advocacy groups are gearing up for a debate on longer-term reforms. They know the odds don’t favor Congress adopting a one-year extension of the lower rate again next year. Besides, spending $6 billion to save college graduates $9 a month isn’t a great deal for borrowers or taxpayers. So it’s good that student aid advocates want a better plan. But they aren’t off to a great start. They are gathering support for an outrageously expensive proposal that turns a blind eye to far more worthy aid, like Pell Grants.

The student loan interest rate proposal that is dominating discussions among advocates and other stakeholders would provide borrowers with variable interest rates that would be capped at the current fixed rates of 6.8 percent on Stafford loans and 7.9 percent on PLUS loans for parents and graduate students.

The rate on all newly-issued federal loans would be adjusted annually based on interest rates on short-term (three month) U.S. Treasury debt, plus a markup of two to three percentage points to partially offset costs. Today, that would translate into an interest rate of about 3 percent. If short-term U.S. Treasury rates rise, the rate borrowers pay would too, though it would never exceed 6.8 percent. Such a proposal would represent a return to the policy of the 1990s and early 2000s, except the cap on the variable rate then was 8.25 percent.

This variable-rate-with-a-cap proposal would give borrowers a “heads-I-win, tails-you-lose” arrangement. If short-term rates stay low, borrowers benefit. If short-term rates rise, the loans convert to low, fixed rates and the borrower wins again. When short-term rates decline, the fixed-rate loan converts back to a variable rate, and the borrower wins again.

The policy effectively shelters borrowers from the financial tradeoffs that they would normally face when they choose between fixed and variable interest rates on loans in the private market. Variable rates are lower at first, but can go higher. Fixed rates might be higher on average, but they provide certainty.

The variable-rate-with-a-cap proposal doesn’t, however, make that fundamental tradeoff disappear. It just shifts the cost entirely onto taxpayers.

How much would taxpayers have to pay to provide borrowers with this no-lose insurance policy? According to sources on Capitol Hill, the Congressional Budget Office says it would cost $200 billion over 10 years.

To put this price tag in perspective, Congress could fund an $8,000 maximum Pell Grant (up from $5,550 today) for the next 10 years if it allocated an additional $200 billion to the program over that time period.

Still, there are other options for policymakers to modify student loan interest rates that would make meaningful improvements for borrowers without breaking the bank. One even generates savings (read more here).

Students and aid advocates would be wise to rally around some version of a more feasible interest rate reform proposal in the coming months. But if they really want to get behind a proposal that costs $200 billion, please make it one that supports the Pell Grant program rather than college graduates’ monthly budgets.

One student financial loan expert, Jason Delisle of the left-leaning New America Foundation, points out that there are programs already in existence that ease the repayment burden for unemployed and under employed graduates. He thinks the federal government can help more students in other ways -- such as maintaining funds for Pell Grants going to lower-income students.

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Update: For the most recent post on this topic, check out "Proposed 3.4 Percent Interest Rate Not the Best Deal for Students or Taxpayers."

Congress is now officially deadlocked over how to pay for a one-year extension of the 3.4 percent interest rate offered on newly-issued Subsidized Stafford student loans. The disagreement isn’t over extending the rate, but where to find the extra $6 billion needed to pay for it. In the midst of all the partisan bickering, wouldn’t it be great if Congress could magically lower interest rates for all borrowers without cutting other programs or raising taxes, while reducing budget deficits in the meantime? Take a look at the Congressional Budget Office’s “Reducing the Deficit: Spending and Revenue Options” publication from March 2011 (page 32).

The CBO has provided a cost estimate for a proposal that would link the interest rate on all newly-issued federal student loans—Subsidized and Unsubsidized Stafford, Graduate and Parent PLUS—to long-term U.S. Treasury borrowing rates.  (The CBO isn’t endorsing the proposal, just showing lawmakers how it would ‘score’.) Interest rates would still be fixed for the life of the loan, but the rate would change each year loans are offered based on market rates for Treasury notes. The proposal sets the rate for newly issued loans based on the interest rate on 10-year Treasury notes at the time the loan is issued, and adds a premium of 3 percentage points to it.

That formula would make the rate on loans issued this fall fixed at 4.9 percent, a big drop from the current 6.8 percent rates. What’s more, that rate would be available to all undergraduate and graduate borrowers, unlike the proposal pending in Congress to provide lower rates for only some undergraduates. Of course, next year the rate could be higher or lower depending on what happens to interest rates in the market. The CBO assumes it will be higher. That’s where the deficit reduction (i.e. cost savings) comes in.

If and when the interest rates on 10-year U.S. Treasury notes rise, the fixed interest rate on newly-issued student loans will also increase. Once rates on those securities rise above 3.8 percent – the rates are currently 1.9 percent – the interest rate on newly issued student loans will exceed 6.8 percent, the current fixed interest rate. Because CBO assumed that interest rates will rise in the future, it assumed that borrowers will pay higher rates in the future than under current law, reducing spending and the deficit. According to the estimate, this new rate structure would reduce the deficit by $52 billion over ten years.

Keep in mind that CBO calculated this estimate in early 2011 when long-term interest rates were higher. That means the savings that would be ‘scored’ under the same proposal today are likely less. At the same time, the proposal CBO used for its estimate would charge the same interest rate on PLUS loans to graduates and parents of undergraduates as the rates on Stafford loans, a break from historical policy. If lawmakers opted to charge a higher interest rate for PLUS loans like they do currently, the total savings would be more in line with CBO’s 2011 estimate. 

Some student aid advocates and policymakers will likely dismiss this proposal because it could mean that future borrowers take out loans at rates higher than 6.8 percent. Still, that seems like a better policy than what we have today – fixed 6.8 percent rates on loans issued every year no matter what happens in the market. Furthermore, it will make rates on newly-issued loans more closely resemble the interest rates private lenders charge on home mortgages, something many student aid advocates seem to want.

The market-based, fixed-rate proposal like the one CBO scored in its 2011 publication is also better than a variable rate structure where rates are reset on all outstanding loans once a year. Too many advocates and policymakers seem to be falling for the allure of low variable rates as a way out of the current interest rate debates. But variable rates are a shortsighted solution. In fact, the drawbacks of variable rates – uncertainty and the risk that rates remain higher for years – are why Congress adopted fixed rates in the first place.

The lesson here is that fixed rates are an important benefit for borrowers as they provide a measure of certainty – but the rates on newly-issued loans do need to adjust when interest rates in the market change. The proposal outlined in a 2011 CBO cost estimate shows that Congress can adopt exactly that policy and save money at the same time.

"The Ryan budget does not include any proposal to postpone the rate increase," said Jason Delisle, director of the Federal Education Budget Project at the New America Foundation. But, he said, "the House Republicans did pass a bill to prevent the rate ...

This post was first published as a response to a prompt on the National Journal’s Education Experts Blog on May 1, 2012. The prompt and responses from other experts can be viewed on the National Journal’s website here.

It’s important to think about “what protections [for borrowers] would be needed,” if Congress made changes to the interest rates on federal student loans. Even so, it seems hardly anyone understands the protections borrowers already get under the current federal loan system. What else could explain President Obama and Mitt Romney’s mutual misunderstanding that charging lower interest rates on Subsidized Stafford loans helps borrowers who can’t find a job?

Subsidized Stafford loans for undergraduates – the only type eligible for the 3.4 percent interest rate – include a special interest-free benefit. The interest clock on these loans is frozen while a borrower is enrolled in school and for up to three years if a borrower is unemployed or meets the rules for economic hardship. This means that keeping the interest rate on newly-issued Subsidized Stafford loans at 3.4 percent will not affect unemployed borrowers. The interest rate for these borrowers is automatically 0.0 percent.

Borrowers working part-time or in low-paying jobs need not worry about the interest rate on Subsidized Stafford loans (for three years) either if they enroll in the income-based repayment plan. This plan caps a borrower’s monthly payment at a share of his disposable income, regardless of the interest rate on the loans. But the deal is even sweeter for Subsidized Stafford loans. If a borrower’s monthly payment is too low to cover the interest that accrues, the government forgives it – up to three years’ worth.

These protections make the rhetoric about lowering interest rates to help college graduates weather a weak job market ill-informed at best. By definition, the campaign to keep interest rates lower on Subsidized Stafford loans is about keeping rates lower only for those borrowers who are employed and earn enough to be ineligible for the income-based repayment program. It is those fully-employed borrowers who are most able to swing the extra $9 a month (at most) that another year of loans offered at a 3.4 percent interest rate would otherwise save them.

Targeting a precious $6 billion right now to borrowers who have jobs and incomes high enough to cover the higher rate seems out of touch, especially when the Pell Grant program needs approximately that much next year to stave off a massive cut to the aid it provides.

While $1,000 is nothing to scoff at, that’s only a “marginal increase” in what students currently owe, according to Jason Delisle, the director of the Federal Education Budget Project at the New America Foundation. According to a recent blog post by Delisle, a Stafford loan recipient who borrowed at the 3.4 percent interest rate, rather than the unsubsidized 6.8 percent rate—assuming he borrows the $5,550 maximum allowable amount as a third- or fourth-year student—would save a total of only $9 each month.

The House is set to vote Friday on a GOP proposal to keep some student loan interest rates at current levels. Many students have been concerned at news that the current 3.4 percent rate could double if Congress fails to extend the 2007 College Cost Reduction and Access Act. Host Michel Martin talks with Jason Delisle of the New America Foundation.

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