Federal Student Loans

The student loan interest rate debate will come to a head early this summer as the 3.4 percent interest rate on Subsidized Stafford student loans nears its July 1 expiration. When that deadline hits, the rate will revert to 6.8 percent, the rate currently charged on Unsubsidized Stafford loans. Last week, we published a piece detailing the half-dozen reform proposals currently floating around Capitol Hill and produced some takeaways on each. But there are still other misconceptions to clear up.

One of the current interest rate plans, Senator Elizabeth Warren’s (D-MA) proposal to reset Subsidized Stafford interest rates for just one year at the Federal Reserve bank lending rate of 0.75 percent, is perhaps the most controversial. Federal Education Budget Project Director Jason Delisle last week published an op-ed on Yahoo! Finance detailing one of the underlying problems with the plan: that the government already loses money on Subsidized Stafford loans. Delisle wrote:

What about Senator Warren’s claim that the government makes money off loans to low-income students?… She points to figures that the non-partisan Congressional Budget Office says “do not provide a comprehensive measure of what federal credit programs actually cost the government and, by extension, taxpayers.” In fact, when the budget office “accounts more fully… for the cost of the risk the government takes on when issuing loans,” it reports that Subsidized Stafford loans – those made to low-income students – cost taxpayers $12 for every $100 lent out, or $3.5 billion per year. If the loans cost $3.5 billion a year when the government charges a 6.8 percent interest rate, cutting the rate to 0.75 percent would more than triple that cost.

Warren’s claim that the government is profiting on student loans – and therefore that it should drop the interest rate it charges on federal loans for low-income students dramatically – is a rhetorical one. Delisle spoke to Dylan Matthews of The Washington Post’s Wonkblog to clear up the issue. Matthews writes:

Just like any institution, the CBO determines the cost of loans by “discounting all of the expected future cash flows associated with the loan or loan guarantee—including the amounts disbursed, principal repaid, interest received, fees charged and net losses that accrue from defaults—to a present value at the date the loan is disbursed.” To do that, it needs to settle on a “discount rate,” which is usually the expected rate of return on the loan in question. Banks and other private institutions generally estimate that by finding loans with similar risks and maturities to the one being evaluated, and then using those similar loans’ rates of returns.

The CBO does not do that. It discounts all government loans using the returns on Treasuries of similar maturity. So a 30-year student loan would be compared to a 30-year Treasury bond. But Treasuries are the safest bonds in the world... To capture the true risk of these loans, you’d need to discount using the rate of return for another loan with similar risk. Comparing them to Treasuries make them seem safe no matter what the actual risk.

The claims that student loans turn a profit for the government are based on unrealistic, rigged budgeting mechanisms. And looking at a fair accounting method, the one recommended by the CBO, it’s pretty clear that Subsidized Stafford loans are actually costing the government (and taxpayers) $12 for every $100 lent.  This may seem a wonky, insider issue, but with Congress under rigid fiscal constraints right now and members arguing that the U.S. needs to reign in the deficit, costs matter.

For more on how the government is losing money on these loans, check out this background page from the Federal Education Budget Project. You can also see the Wonkblog article here, and Delisle’s op-ed about Senator Warren’s proposal here.

Be sure to check out this op-ed on Yahoo Finance regarding Senator Warren's proposal to cut interest rates on federal student loans.

This Ed Money Watch post has a rundown of all of the pending proposals, including the one sponsored by House Republicans that will be up for a vote next week.

A clear divide has emerged in the debate over the interest rates on federal student loans. In one camp are House and Senate Republicans, along with President Obama; in the other are the congressional Democrats. But before explaining what makes those camps different, a quick refresher on the interest rate issue is in order.

Undergraduates are currently charged two different fixed interest rates: 3.4 percent on Subsidized Stafford loans and 6.8 percent on Unsubsidized Stafford loans. Loans issued on or after July 1, 2013, though, will carry the 6.8 percent rate. (That policy has its roots in a 2006 Democratic congressional campaign and you can read the history here.) The rates are different for graduate students and parents of undergraduates, and were never subject to the expiring policy. The two-rate policy on undergraduate loans was originally set to expire last year, but President Obama called for extending it for one year. Congress went along with that at a $6 billion cost.

Unfortunately, the interest rates on federal student loans are just numbers Congress made up (seriously). And in debating the expiring two-rate policy last year, lawmakers never tried to come up with a more rational approach. Instead, they just extended the made-up numbers. We criticized that approach and offered an alternative last year.

What a difference a year makes.

A real debate about student loan policy is now underway in Congress. House Republicans (Kline), Senate Republicans (Coburn), and President Obama have all put forth proposals to peg student loan interest rates to the rates on U.S. Treasury notes. While their proposals are all slightly different, these lawmakers have put forth proposal that would be permanent, fiscally sustainable, keep rates well below market rates for all borrowers, and ensure that those interest rates reflect economic conditions.

So here is where the divide in the debate emerges. Other lawmakers – House and Senate Democrats mainly – have proposed either gimmicky solutions, wildly expensive ideas, or a two-year extension of the made-up rates. A side-by-side table is available here. 

• Rep. Courtney suggests a two-year extension of current policy.

• Senator Warren would set the rate at 0.75 percent, but only for undergraduates and only for Subsidized Stafford loans, and only for one year. The cost would be close to $12 billion, by our estimates.  Senator Warren claims her proposal has something to do with an emergency lending program at the Federal Reserve, which is really just a rhetorical gimmick that has no practical effect.

• Senator Reed introduced a bill that requires the Department of Education to set the rates at the “cost” of the program, and let borrowers with outstanding loans refinance to those rates. That would drop rates to about 2% by our estimates (official cost estimates understate the cost of the program, so the rates would be artificially low).  Even though the program would operate at “cost,” the reduced interest payments compared to current law would actually show up in the budget as increasing the deficit (i.e. as a cost) of about $175 billion over the next 10 years according to numbers released by the Congressional Budget Office yesterday. That is before factoring in the refinancing component, which could easily top $50 billion in costs.

We’ve received a lot of inquiries about the merits of all of these proposals. Obviously, the shortcomings of the congressional Democrats’ proposals need no further explanation. The president’s and the House and Senate Republicans’ proposals, on the other hand, are all a huge improvement over current policy – and a huge improvement over what lawmakers were discussing last year. None would be a step backwards.

That said, the House proposal gives borrowers the most options and protections – floating interest rates with the option to take a fixed rate and an interest rate cap – but those options and protections mean the proposal has a lot of moving pieces that will require a lot of explaining. It will also confuse borrowers, some of whom will inevitably make a bad choice on when to lock in their interest rate. The president’s proposal needlessly charges undergraduates two different interest rates just to score political points. The Senate Republican bill, on the other hand, has no complicated options and no moving pieces, or gimmicks to score political points.

Those should be guiding principles as Congress and the president work to finalize a bill by July 1.

The president’s fiscal year 2014 budget request includes a proposal for setting interest rates on newly issued federal student loans. The fact that the president excluded a cap in his proposal (as did the New America Foundation) has rankled student aid advocates. We’ve argued that the new income-based repayment (IBR) program that became available last year for students who began borrowing after October 1, 2007 ensures that a borrower’s monthly loan payments are capped – which therefore makes it a more generous benefit than an interest rate cap.

Read the rest of this post on Ed Money Watch.

In a hearing before the U.S. House Committee on Education and the Workforce this week, Terry Hartle of the American Council on Education (the higher education lobby) hinted that his association has had a major change of heart on income-based repayment for federal student loans. Or so it seems. 

At issue was a proposal by Rep. Tom Petri (R-WI) that would move the entire loan program to an income-based repayment system administered through employer payroll withholding. Borrowers would make payments at 15 percent of their discretionary income and there would be no loan forgiveness. Instead, total accrued interest would be capped at 50 percent of what a student borrows. Those terms are far less generous than the plan the Obama administration proposed in 2010 and enacted late last year, called Pay As You Earn or Income-Based Repayment. Under that plan, borrowers pay 10 percent of their incomes, 33 percent less per month than the Petri plan, and have their debt forgiven after 10 or 20 years.

Mr. Hartle told the Committee that the Petri proposal “could become an incentive to over-borrowing,” an outcome that he said, “no one wants.” If the Petri proposal more or less rolls back the Obama administration’s Pay As You Earn and Income-Based Repayment plans and replaces them with something that requires borrowers to pay more and for longer, one wonders what the American Council on Education’s position is on the Obama administration plan, which is in current law and available to nearly all new borrowers going forward.

Does Mr. Hartle believe the plan available now for recent borrowers encourages over-borrowing too? If so, that would be a new position for the American Council on Education.

When the president laid out the details of his Pay As You Earn plan in 2010, the American Council on Education rushed to send the White House a letter (available here). The Council’s letter expresses no concern about incentives for over-borrowing, despite the fact that the president’s program is far more likely to encourage over-borrowing (as outlined in this New America Foundation paper) than the Petri proposal because its terms are so much more generous for borrowers, mainly graduate students. The letter is a straight-up endorsement of the president’s proposal to “expand” benefits under Income-Based Repayment.

What explains the inconsistency in ACE’s “strong support” for the Obama administration’s plan and its cautionary warnings about over-borrowing under the Petri plan? (Maybe their position has evolved since they endorsed the Obama administration plan in 2010, and the group does in fact have concerns about it now.) It is unfortunate that the Committee didn’t think to ask Mr. Hartle to explain that glaring inconsistency.

Disclosure: The author worked for Rep. Petri from 2000 to 2005.

By Deanne Loonin

President Obama has committed his administration to achieving new levels of openness in government. When it comes to the Department of Education, however, there appears to be far more “talk the talk” than “walk the walk” in these efforts and the “new era” of open government looks a lot like the old way of doing business.

This disappointing record has serious implications for student loan borrowers and their advocates as basic information about Department of Education policy is harder than ever to obtain. 

Take, for example, the Department’s policy regarding the commissions it pays student loan collection agencies.

The president’s fiscal year 2014 budget request includes a proposal for setting interest rates on newly issued federal student loans. Rates would be fixed for the life of the loan and set at a rate equal to the interest rate on 10-year Treasury notes, plus 2.93 percent for Unsubsidized Stafford loans, the most widely available federal student loan. (Subsidized Stafford loans would be set at the 10-year Treasury rate plus 0.93 percent, and PLUS loans for parents of undergraduates and for graduate students set at 10-year Treasury plus 3.93 percent.)  The rate would not be subject to a nominal cap. The approach is similar to one highlighted a year ago on this blog and again this year in the New America Foundation paper Rebalancing Resources and Incentives in Federal Student Aid.

The fact that the president excluded a cap in his proposal (as did the New America Foundation) has rankled student aid advocates (see here, here, and here). We’ve argued that the new income-based repayment (IBR) program that became available last year for students who began borrowing after October 1, 2007 ensures that a borrower’s monthly loan payments are capped – which therefore makes it a more generous benefit than an interest rate cap. Further, the program’s 10-year and 20-year loan forgiveness terms reduce, cap, or eliminate the interest that a borrower must actually pay, depending on the situation.

How does it do that? A borrower’s payments under IBR are based on his income, and the total time he is required to repay is limited through loan forgiveness, so there is a limit to how much he can ever pay on his loans -- and that limit can make the nominal interest rate on the loan or the amount borrowed irrelevant.

In a recent blog post, the Institute for College Access and Success (TICAS) offers an example in which a borrower pays more in total lifetime payments when the interest rate on the loan is higher. Is that inconsistent with the above statement? Not at all.

The borrower in the TICAS example has $20,000 in debt, has an Adjusted Gross Income of $30,000, and presumed household size of 1 (i.e. not married/married filing separately and no children claimed as dependents). Therefore, we can plot the interest rate cap that IBR would provide on her loans at various debt levels and based on whether she will have her debt forgiven after 10 or 20 years.

The Income-Based Repayment plan reduces and ultimately caps the borrower’s interest rate at 12.8 percent. After that point, any unpaid interest or principal balance on the loan will be forgiven due to the maximum term of 20 years under IBR. And if the borrower had $30,000 in debt, IBR caps the interest rate at a very low 3.6 percent. At $50,000 in debt, her interest rate is capped at 0.0 percent – given her income she won’t pay even as much as her initial loan balance, so her interest rate is irrelevant. Why the big differences in interest rate caps? Again, her total payments on her loan have a limit based on her income and the 20-year term of the loan -- so more debt must translate into a lower interest rate cap and lower debt results in a higher interest rate cap.

Now suppose the borrower with $20,000 in debt in the TICAS example works for a non-profit, thereby qualifying for public service loan forgiveness after 10 years of payments. With PSLF, IBR caps her interest rate at 0.9 percent. At $25,000 in debt the interest rate is effectively capped at 0.0 percent. These figures are so much lower than under the 20-year forgiveness becuase the total payments this borrower could ever make are much lower, all because the loan term cannot exceed 10 years.

And if the borrower has a child to declare in her household size, all of the numbers cited above are lower because the program increases the allowable income exemption for each dependent child in calculating the monthly payment. But rather than write out more examples, the table above is instructive. The information in the table is for a borrower who matches the income profile of the borrower in the TICAS example. We use the New America Foundation IBR calculator for all calculations. 

As the table above demonstrates, IBR provides very valuable benefits by reducing, capping or eliminating interest rates on federal loans. (However, the perverse incentives to borrow more and the windfall benefits for high-income high-debt borrowers, mainly graduate students should be addressed.) No doubt, a nominal interest rate cap written into law can provide even greater benefits for borrowers in certain circumstances. But is a cap necessary given the benefits of IBR and would it be worth the extra costs? Probably not, and the Obama Administration agrees.

President Barack Obama submitted his fiscal year 2014 budget request to Congress on April 10, 2013. The New America Foundation has reviewed the president’s proposals and generated a list of key questions that policymakers, the media, stakeholder groups, and the public should ask about the proposals.

Early Learning and PreK-12 Education

1. The president’s budget proposes to partner with states to provide high-quality pre-kindergarten programs for all low- and moderate-income 4-year-olds, funded with $75.0 billion over 10 years through a 94-cent increase in the federal tobacco tax. The corresponding budget documents provide some guidance on how quality will be defined, mentioning full-day programs, small class sizes and low child-adult ratios, but they are silent on other issues. How specifically will quality be defined? Will pre-K teachers be required to earn bachelor’s degrees or demonstrate specialization in early childhood education? What about states that want to make more investments in pre-K, but cannot meet the match required by the federal government? What safeguards will be put into place to ensure that the funding would not become another siloed funding stream?  And will any guidance be issued to encourage states to – in the long-term – fund pre-K and kindergarten the same way 1st through 12th grade are funded?

2. The president’s proposal includes $300 million for the Promise Neighborhoods program, a $240 million increase over last year. Some of the program’s funds will reside under a new inter-agency header, Promise Zones, in which housing, criminal justice, education, and economic growth efforts are all deployed within a single geographical area. The number of awards will be split between planning grants and implementation. Is the administration counting on sustaining this higher level of funding for the program moving forward? Should a relatively new program bring on so many new communities, rather than focusing on deepening services for existing grantees?

3. The president proposes $300 million for new competitive grants to encourage high schools to strengthen college and career readiness by redesigning traditional programs and creating partnerships with community colleges and employers so that students graduate with college credit and career skills. How would the Department of Education identify high-quality models that are likely to improve students’ postsecondary readiness, and would certain criteria be prioritized?  Would grantees be required to match any of the funding? 

And how would the High School Redesign competition interact with similar proposals? Dual enrollment, Advanced Placement (AP), early college high schools, and other accelerated programs would be supported in the president’s proposed $102 million College Pathways and Accelerated Learning initiative. The administration would simultaneously overhaul Career and Technical Education programs within high schools that operate under the Perkins Act through a $1.1 billion budget request. And an additional $32 million would supplement Perkins funds to address local workforce needs and support adult learners by allowing them to earn high school and college credit through dual enrollment. How would the department ensure these efforts complement, rather than compete with, one another? 

4. The president’s budget request includes $659 million for a School Turnaround Grants program. This would maintain spending for state School Improvement Grants (SIG), but would also expand the program to include all priority schools under No Child Left Behind (NCLB) waivers and add $125 million in competitive funding for districts to build capacity and maintain progress in schools nearing the end of their 3-year SIG interventions. Will the department issue guidance to encourage schools to add early learning efforts, like pre-K and full-day kindergarten, as part of school turnarounds? And what will the criteria be for districts applying for the new capacity-building grants? How will the department define successful district strategies to support persistently low-achieving schools? Districts’ lack of capacity has been one prominent criticism of the SIG program, but given that over $3 billion has been spent on SIG already, is the additional $125 million too little, too late?

5. The president proposes $215 million for the Investing in Innovation program (i3), an increase of $66 million. But nearly all of the increase ($64 million) would go toward a new program called Advanced Research Projects in Agency-Education (ARPA-ED) modeled after similar efforts in the Departments of Defense and Energy. The i3 fund provides competitive grants to school districts, nonprofits, and consortia to implement, validate, or scale up promising reform efforts. Would the i3 program continue to focus on certain reform initiatives, like teacher and leader effectiveness, or would the program shift focus to other areas, including early learning and student achievement in STEM subjects? Would ARPA-ED share the i3 focus? And how will the Obama administration ensure that ARPA-ED avoids redundancy with the Institute for Education Sciences?  

6. The president proposes to flat-fund the Assessing Achievement program at $389 million, which would replace State Assessments funding in NCLB. The Common Core assessment consortia, PARCC and SmarterBalanced, have been supported with $360 million in 2009 stimulus funds, set to expire in the fall of 2014 – before the tests are fully administered in the spring of 2015. The two consortia would be eligible to compete for an additional $9 million in funding under Assessing Achievement, while the remaining $380 million would be allocated by formula to states. Given pressure for additional assessments in PreK-3rd grade and untested subjects, technology upgrades and increased bandwidth, formative assessments, improved test security, aligned curriculum and professional development, and other supports, will states have sufficient resources to transition to the Common Core assessments while also maintaining and improving their other assessments? And is $9 million sufficient to complete and sustain the work of the Common Core assessment consortia during their first year of full implementation? What guidance will the department provide to help states and the consortia prioritize their activities heading into the critical 2014-15 school year?

Higher Education

7. The president proposes expanding the recently enacted, more generous Income-Based Repayment plan for federal student loans, Pay As You Earn, to all borrowers rather than just new borrowers as of October 1, 2007, and eliminating the tax on loans forgiven for borrowers. Last year, the New America Foundation argued for those exact policy changes – provided that Congress and the administration first address the perverse incentives and windfall benefits the program will provide to graduate and professional students and the schools that enroll them.                

If Pay As You Earn is expanded to all borrowers and loan forgiveness benefits are made tax-free, as the president is proposing, isn’t it even more important to rein in the program’s windfall benefits and perverse incentives? Does the administration have any thoughts on how to address these issues while maintaining the program’s benefits for lower-income and lower-debt borrowers?             

8. The president proposes setting interest rates on student loans at the 10-year Treasury note plus an additional 0.93, 2.93, and 3.93 percent for Subsidized and Unsubsidized Stafford and Grad PLUS loans, respectively.  The rate would adjust every year for newly issued loans based on the Treasury rate, but is fixed the life of the loan. The proposal closely mirrors one originally proposed by the Education Policy Program’s Jason Delisle.

Unlike Delisle's proposal, the interest rate in the president’s budget for Subsidized Stafford loans is lower than those for other loans. However, the Income-Based Repayment program makes the lower rate on Subsidized Stafford loans an unnecessary benefit, given that loans can always be paid as a low percentage of income regardless of the interest rate. What is the justification for the lower rate? Why provide an extra benefit for borrowers when Income-Based Repayment is available for struggling borrowers? Couldn't the budgetary resources used to provide the lower rate be put toward the Pell Grant program instead, where they are certain to help low-income students?

9. The president proposes a program that would allow non-accredited providers of learning to receive federal funding for two-year degrees that are both free to the student and high-quality, with demonstrable outcomes.  The goal of Pay for Success is to provide students with alternate pathways for high-quality, low-cost higher education.  Providers would front the costs and be reimbursed only when and if students succeed. This would allow learning acquired and/or certified through means as varied as MOOCs, work-based training, AP exams, and more to be packaged together to create a free, coherent, high-quality competency-based degree.

The budget documents indicate that demonstrated competencies, passage of field-appropriate licensing tests, and job placement are possible indicators of success. How will these indicators be determined? Will the agreed-upon indicators be transparent? How will the outcomes be verified? Will additional measures include acceptance of the two-year degrees for transfer by four-year institutions? How would this work if the “degrees” are not accredited? If students can demonstrate competencies and the outcomes are solid, what would be the justification for not accrediting these new degree programs? How would findings from this experiment on an outcomes-focused delivery model inform the broader conversation around higher education quality?

10. Providing students and families with better information in order to help them make more informed college-going choices is a recurring theme in the budget. It is highlighted as an area for state reform in the proposed $1.0 billion Race to the Top College Affordability and Completion competition and given as an example of an area to study under a $67.0 billion proposed higher education/financial aid research and evaluation program. And the president unveiled his College Scorecard in the 2013 State of the Union address to provide better, more actionable data to students in a user-friendly manner. Yet one of the main indicators on the Scorecard—employment—is essentially blank. Although the department has said that it is working to provide the information, it is not clear how or when that will occur. Given bipartisan interest in better postsecondary outcomes data, what is the department’s plan to provide accurate employment data to students? Does the president plan to make the Scorecard mandatory? If so, when? If the department wants to encourage states to provide better information, shouldn't it also lead by example?

Education advocates have been lauding the budget resolution wending its way through the U.S. Senate. They praise the Senate budget resolution (aka the “Murray budget,” so named for Budget Committee Chair Patty Murray) for rolling back the increases in origination fees for student loans and for addressing the July 1 expiration of the 3.4 percent interest rate on Subsidized Stafford loans for undergraduates. These advocates have either been duped or are simply giving Senate Democrats a free pass: The Murray budget does not include funding for any changes to student loans – or any education programs on the entitlement side of the budget, for that matter.

Read the full post here on Ed Money Watch.

Education advocates have been lauding the budget resolution wending its way through the U.S. Senate. They praise the Senate budget resolution (aka the “Murray budget,” so named for Budget Committee Chair Patty Murray) for rolling back the increases in origination fees for student loans and for addressing the July 1 expiration of the 3.4 percent interest rate on Subsidized Stafford loans for undergraduates. These advocates have either been duped or are simply giving Senate Democrats a free pass: The Murray budget does not include funding for any changes to student loans – or any education programs on the entitlement side of the budget, for that matter.

Congressional budget resolutions are drafted each year by the House and Senate Budget Committees to set spending and revenue targets for at least the next five years. The budget resolution is broken down into budget functions that help set the limits on future spending for different agencies.

Each budget function has a “baseline funding” level, which refers to current law. If senators intended to leave education programs exactly as they are under current law, senators would set funding at the baseline in the budget resolution.But if the senators drafting the budget resolution want to “make room” for more spending on education programs like student loans – say, to extend the 3.4 percent interest rate on Subsidized Stafford loans – then the budget function for education (function 500) needs more funding in it than the baseline.

So if the Murray budget was serious about making changes to education programs, we could look at the education budget function and we would see an increase in funding above the baseline. For example, a one-year extension of the 3.4 percent interest rate on Subsidized Stafford loans would cost about $6 billion above baseline. But there is no such funding increase in the Murray budget. Education funding is exactly at baseline, and no additional funding is provided for education programs on the mandatory side of the budget, such as student loans (see table below).

Why did Senate Democrats opt not to include the additional funding in the budget resolution? Because that would have showed up as additional spending. Instead, the Senate Democrats included a “deficit-neutral reserve fund” for higher education programs that includes no spending numbers whatsoever. Why? Because that approach includes no spending numbers whatsoever. That way the budget resolution can have its cake and eat it too. Its supporters can boast about new spending for student loans but exclude that spending from any actual spending number in the budget resolution.

That is a convenient trick if you can get away with it. Education advocates seem willing to play along with a wink and nod – or maybe they have been duped. Perhaps they should ask Senate Democrats to show them where the money is for more spending on student loans. And remember, spending is measured in numbers, not words. Do not fall for the “reserve fund” trick.