Student Loan Interest RatesOn July 1, the inter­est rate on new fed­er­al sub­si­dized Stafford Loans for under­grad­u­ate stu­dents doubled–from 3.4% to 6.8%. This increase brings the inter­est rate on sub­si­dized Stafford Loans in line with the rate on unsub­si­dized Stafford Loans, which was already at 6.8%. The rate change is only for new sub­si­dized Stafford Loans tak­en out after July 1.

What’s the dif­fer­ence between sub­si­dized and unsub­si­dized loans? With sub­si­dized Stafford Loans, the fed­er­al gov­ern­ment pays the inter­est while the stu­dent is in school, dur­ing the six-month grace peri­od after grad­u­a­tion, and dur­ing any loan defer­ment peri­ods. With unsub­si­dized Stafford Loans, the stu­dent pays the inter­est dur­ing these peri­ods. Eli­gi­bil­i­ty for sub­si­dized Stafford Loans is based on a stu­den­t’s finan­cial need, as deter­mined by the fed­er­al gov­ern­men­t’s finan­cial aid appli­ca­tion, the FAFSA.

Accord­ing to a June 2013 report enti­tled The Caus­es and Con­se­quences of Increas­ing Stu­dent Debt by Con­gress’ Joint Eco­nom­ic Com­mit­tee, the rate increase on sub­si­dized Stafford Loans will result in the aver­age col­lege bor­row­er pay­ing an addi­tion­al $2,600 in inter­est over the life of the loan (a stan­dard 10-year repay­ment term), and will cost an addi­tion­al $4,500 in inter­est over the life of the loan for stu­dents who bor­row the max­i­mum aggre­gate sub­si­dized Stafford Loan amount of $23,000 dur­ing their under­grad­u­ate years.

Background

You may have heard in the news that Con­gress was work­ing on a bipar­ti­san solu­tion to avoid the inter­est rate increase. Yet despite sev­er­al last-minute attempts at com­pro­mise, law­mak­ers dis­agreed over key details and no sin­gle plan won suf­fi­cient sup­port.

A House bill passed ear­li­er this year would have tied the inter­est rate on Stafford Loans (sub­si­dized and unsub­si­dized) to the 10-year Trea­sury note plus 2.5%, with the rate reset­ting (vari­able) each year. Pres­i­dent Oba­ma in his bud­get also pro­posed link­ing the rate on Stafford Loans to the yield on the 10-year Trea­sury note, but with a small­er dif­fer­ence between the two, and more impor­tant­ly, fix­ing the rate for the life of the loan. The Sen­ate had its own ideas, with Democ­rats and Repub­li­cans dif­fer­ing in the way the rate should be deter­mined and oth­er details, such as whether the gov­ern­ment should use some of the mon­ey it makes on the loans to reduce the fed­er­al deficit. In the end, a deal did­n’t get done and the rate on sub­si­dized Stafford Loans dou­bled from 3.4% to 6.8% on July 1 as it was sched­uled to do.

The issue has tak­en on added sig­nif­i­cance after many reports, includ­ing some by the Fed­er­al Reserve Bank of New York, have shown that despite more aggres­sive debt shed­ding by Amer­i­can con­sumers since the reces­sion, stu­dent loan debt con­tin­ues to grow (it now sur­pass­es total out­stand­ing cred­it card debt) and has increas­ing­ly become a finan­cial black cloud for many stu­dents and their par­ents. Indeed, many observers have raised ques­tions about the stu­dent debt domi­no effect on the over­all econ­o­my as there are now 37 mil­lion bor­row­ers with out­stand­ing stu­dent loans.

What’s next?

There’s talk that leg­is­la­tors will reach a deal after they return from their July 4th recess, and that any deal will apply retroac­tive­ly. In the mean­time, stu­dents who plan on tak­ing out new sub­si­dized Stafford Loans for this aca­d­e­m­ic year will need to wait and see whether their inter­est rate will stay at 6.8%, and col­leges will be wait­ing to see what hap­pens as they pre­pare to send out fall semes­ter bills. Stay tuned.

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