NAICU Washington Update

House Committee Considers Wide Range of Student Loan Issues

March 20, 2013

House Considers Student Loan Issues

The House Education and Work Force Committee held a hearing March 13, “Keeping College Within Reach: Examining Opportunities to Strengthen Federal Student Loan Programs.” Chair John Kline (R-Minn.) outlined a broad scope to the hearing, including “a larger conversation of federal student aid programs.” The hearing, however, stuck to its billing and focused on several major themes related to the loan program: how best to set interest rates, the cost of the loan programs, repayment models, and borrower eligibility. (Witnesses’ written testimony is available on line.)

Judging from the comments at the well-attended hearing, student loan restructuring will be one of the major themes in this Congress, even as members struggled to comprehend the broader social implications and esoteric financial estimating models mentioned by witnesses.

Argument for Variable Rate Interest

MIT economics professor Deborah Lucas argued for going from the current fixed interest rates on student loans to a variable rate, saying the current rate “has adverse consequences for students, for taxpayers, and for the stability and control of budgetary costs.” She made the point that, over time, fixed rates get out of whack with the market and this translates to very different amounts of subsidy for students. In the current sluggish economy, for example, the subsidy is comparatively low given that the fixed rate of 6.8 percent for unsubsidized student loans is higher than the rate for many other types of loans.

She asserted that adopting an annually updated, market-indexed rate for determining the interest rate would reduce the volatility of the subsidies. The “generosity” of the subsidy could be controlled by choosing an appropriate “interest rate spread”; that is, the percentage added to the underlying federal index, such as Treasury bills.

Jason Delisle, director of the Federal Education Budget Project at the New America Foundation, agreed that over time fixed student loan interest rates provide different levels of subsidies, and proposed using a system that set life-of-the-loan, T-bill-indexed rates at the time the loan is issued.

Justin Draeger, president of the National Association of Student Financial Aid Administrators (NASFAA), also spoke to the fact that the “federal student loan interest rate is out of step with market rates,” and makes some private student loans – without the consumer protections of federal loans – look more attractive. He cited a Sallie Mae loan with no origination fees or prepayment penalties, at a rate of 2.25 percent. Ironically, this was the way federal student loan rates operated in the past, and were changed to a fixed rate in the 1990s.

Cost of the Student Loan Interest Rate

From a federal budget perspective, the cost of the subsidies to the government can vary with fixed interest rates. According to OMB estimates, the federal subsidy rate for student loans was 5.12 percent in 2006, meaning student loans cost taxpayers about 5 cents on every dollar issued. Now, however, the government makes a huge profit on loans, especially in the PLUS programs. According to the Congressional Budget Office, the federal government “expected to earn 64 cents for each dollar lent to graduate students in the federal PLUS loan program in 2013.”

While there was agreement that the subsidies of variable loans could be less volatile than those for fixed-late loans, establishing a formula for determining the variable interest rate is still being debated and will shape the future contours of the loan program. Much of the current controversy boils down to whether the federal government should use the method specified in the Federal Credit Reform Act -- basically the accrual-based, cost to the government method, or the “Fair Value Estimates” method, favored by House Budget Chair Paul Ryan (R-Wis.), that adds in the costs of potential risks if the loans were offered on the private market. Due to the assumption of additional risk in the latter method, program costs assessed under it are higher. (For additional background on the decades-long debate see the Congressional Research Service document, Subsidy Cost of Federal Credit: Cost to the Government or Fair Value Cost?)

On this topic of federal cost, Delisle added a little excitement to the hearing by taking on Rep. Robert Andrews (D-N.J.) and Rep. Rush Holt (D-N.J.), saying it was “ridiculous” to estimate future costs based on past program costs and loan repayment patterns, as Andrews seemed to be considering. Holt additionally expressed concern that Delisle’s interpretation of the cost was too narrow, and didn’t include the value of broader social benefits derived from the loan subsidies.

Income-Based Repayment and Elimination of PLUS and Grad PLUS

Delisle offered a set of recommendations to improve the federal student loan program, but was most concerned about the shortcomings in the income-based repayment (IBR) plan. In his view, the IBR unjustly favors graduate students who take on high levels of debts, get high paying jobs, and have large amount of their debt forgiven. Given the present economy and borrowers’ difficulty in finding well-paying jobs, there is considerable interest in IBR. Both Congress and the Administration have acted recently to make reduced payments available to more borrowers. In addition, Rep. Tom Petri’s (R-Wis.) proposal to create an IBR system that would be administered through employers and the IRS is receiving a lot of attention.

Delisle also recommended ending the PLUS and Grad PLUS programs, which he contends enable over-borrowing and facilitate increases in college tuition. He also argued that if all loans used income-based repayment the in-school subsidy for loans could be eliminated, and no cap on interest rates would be needed. This is because the amount repaid would be limited by the borrower’s income, not the amount of the loan, and might ultimately be forgiven.

Refocus Perkins and SEOG

Charmaine Mercer, vice president of policy at the Alliance for Excellence, argued for the need for a comprehensive review of the Higher Education Act. She also suggested that the Perkins Loan Program and SEOG funds be redirected to address retention and completion, and that the Pell Grant administrative fee paid to institutions be put toward the Pell Grants themselves — a popular theme the alliance also promoted in the recently released Gates-RADD papers.

Possibility of Institutions Limiting Student Borrowing

In addition to NASFAA’s advocacy for a market-based, variable interest rate, Draeger suggested several other ways to lower the amount of debt students assume, and to lessen their defaults. Of primary importance, he asserted, is providing sufficient grant funding to lower students’ need to borrow. He also noted that automatic enrollment in income-based repayment could simplify and improve loan repayment. Enabling colleges to provide additional loan counseling to students, and even to limit borrowing, could also have salutary results.

Behind NASFAA’s position on limiting borrowing by certain borrowers is the association’s research showing that the average student loan defaulter is “a student who went to school for a very short period of time . . . accumulated a small amount of loan debt, had a low GPA, and attended either a community college or proprietary institution.” Seventy percent of student loan defaulters dropped out of college. In addition, schools are not able to limit students in two-year programs from borrowing up to four-year levels, or to limit part-time students from borrowing at full-time levels. Counseling these students or restricting their borrowing could significantly restrict future repayment obligations and defaults.

Related Legislation

In related legislation, Sens. Tom Harkin (D-Iowa) and Barbara Mikulski (D-Md.) introduced the Smarter Borrowing Act on March 13, which strengthens the current entrance and exit loan counseling required by institutions. It also would require that students be notified annually of their cumulative debt and remaining student financial aid eligibility.