Student Loan Interest Rates: A Fixed and Variable Debate

It’s the summer after high school graduation – a time for beaches, summer jobs, and bittersweet farewells to life-long friends. Or, at least that’s how it looks in the movies.

In real life, this summer is for choosing classes, buying dorm room furniture, picking a dining plan, and – for a number of students – signing up for a student loan. Many of these students will choose federally backed loans, commonly known as Stafford and PLUS loans, which means the federal government decides the terms and conditions. In other words, the federal government decides how large these loans can be, the repayment structure, and the interest rate.

And so it is fitting, as summertime sets in, that Congress turns its attention to legislation affecting the interest rates on these federally backed loans. As it stands, the interest rate on federal student loans is set to increase for 3.4% to 6.8% on July 1. This would be a fixed interest rate – meaning that a student would sign a loan agreement knowing in advance how much interest he would pay over the duration of the loan. President Obama, the House of Representatives, and the Senate have all put forth proposals that would change the way in which the federal government calculates the interest rates of student loans. Today, let’s check in on the House proposal.

This week the House of Representatives passed HR 1911, the Smarter Solutions for Students Act, which would lower interest rates for student loans starting on July 1.  Instead of a fixed rate, this bill would make the interest rate a market-based rate. The bill authorizes student loan interest rates to be reset once a year and move with the market. Interest rates would be set using the following formula: Stafford Loans (both subsidized and unsubsidized): 10-year Treasury note plus 2.5 percent, capped at 8.5 percent. PLUS loans (graduate and parent): 10-year Treasury note plus 4.5 percent, capped at 10.5 percent.

Right now, this is a desirable rate on the part of the students. Unfortunately, however, the variable rate prescribed in the bill is capped at a very high rate, so it could eventually rise to 8.5 percent as the economy improves.

In addition, the bill does nothing to improve repayment policies or other benefits that have been stripped from the student loan program over the last few years.  At a time when Congress is intensely interested (rightly so) in student debt issues, it seems counterintuitive that legislation is passed that makes it more difficult for students to plan their financial future on variable loan rates, with fewer financing options and the possibility of extremely high rates of interest.

Stay tuned – we’ll be bringing updated coverage as the Senate takes up the issue.