Student Loan Rates Reset Lower — But Probably Not for Long

The student debt crisis is now being likened to such contentious issues as the draft and health care. We just got a near-term fix. But borrowing rates will rise substantially in a few years.

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Student borrowers can breath a little easier. After much dithering, the federal government is on track to bring back low rates on government-backed college loans before classes begin in the fall—and these rates will be retroactive to July 1, when the old program expired.

But the new low rates won’t work like the old ones. Under a bill likely headed for approval, rates no longer will be set each year by Congress; they will be tied to the bond market and thus subject to market forces. That means student debt will remain relatively cheap for now. But a few years down the road government-sponsored student loans may cost a great deal more.

Ballooning student debt is a crisis. Loans outstanding total more than $1 trillion. “The student loan issue for the millennial generation will rank up there with the draft for our generation,” Robert L. Borosage, a co-director of the Campaign for America’s Future, told The New York Times. In Washington, parallels are being drawn between higher education and health care, according to a Wall Street Journal report.

The draft? Health care? These rank among the most contentious issues in recent American history, and now student debt is being mentioned in the same breath.

One in three adults are currently helping or planning to help pay for a child’s higher education, and 71% are worried about how they will cover the cost, according to a MainStreet survey out today. Of those saving for college, 79% are parents and 10% are grandparents—and they are managing to put away an average of $6,850 annually towards college.

That won’t get the job done. The average cost of in-state tuition, room and board is $12,110 a year at a four-year public university, after scholarships and tax breaks, the College Board estimates. That figure has risen 40% faster than the overall inflation rate the past decade.

More often than not, loans fill the void. So how government sets the rate on the debt it sponsors is a big deal. Sen. Elizabeth Warren is among those who believe the federal government should set the rate at its cost or lower. She has proposed offering students the same rate, for one year, that big banks get from the Federal Reserve: .75%. Don’t count on it. Others believe students should get the same rate that the U.S. offers anyone who buys a 10-year Treasury bond, now yielding just under 2%. In effect, these people want the government to issue T-bonds and use the proceeds to loan students money with no markup.

But that ignores the costs associated with administering federal programs. So under the new bill, the interest rate for undergraduates will be set 2.05 percentage points above the yield on the T-bond, bringing the rate right now to 3.86% instead of the arbitrary 3.4% rate in force for many loans last year and the 6.8% rate that went into effect in July, when the old program expired.

The obvious risk here is that rates will rise. Congressional researchers project that the rate on new loans for undergraduates would be 4.62% for loans taken out next year and 7.25% for loans taken out in 2018. The bill caps the rate at 8.25%. As rates rise, so will the cost of servicing college loans—pretty much guaranteeing that the student debt crisis won’t go away for some time.