Should the 3.4% Rate for Student Loans be Allowed to Expire?

As the House ponders the Senate’s recent agreement on how to fund a Stafford loan extension, Neal McCluskey argues that they shouldn’t bother.

Yes, the rate on subsidized federal loans will double on July 1 absent congressional action, but that needs to be put into context to see that it’s a potential “crisis” — as I heard it described on a radio news report last Friday – akin to your yacht sinking. Your toy, bathtub yacht.

The rhetoric centers around the doubling of the interest on subsidized loans from 3.4% to 6.8%, which obviously sounds like a steep hike, but McCluskey analyzes its real term effect. He notes that the rate increase will only affect loans originated after July 1 and will not, as is commonly implied in reporting, see the rates on existing subsidized loans double.

Also, the rates have only been 3.4% for the past year — not the last five. The 2007 law that set up the subsidized loans as a supposedly temporary relief measure set them on a gradual decline from 6.8% to 3.4%.

Third, while a rate doubling sounds big, the practical effect according to the White House’s own calculations will be to add about $1,000 to an average loan over its lifetime, which is about ten years. That translates into an additional $8.33 per month — less than the cost of a DC movie ticket.

Freezing the rate for another year, which comes with an estimated $6.7 billion price tag for the country, will do nothing to ease the suffering of middle-class families, despite recent claims by President Obama. Most loans originated after July 1, and so affected by the return to the standard 6.8% rate, won’t even begin to be repaid for at least another 18 months; allowing a year for seniors to graduate and then the six month repayment grace period.

McCluskey argues that an extension is bad policy. Creating artificially cheap student loans has been shown to be part of the cause for the skyrocketing cost of tuition. They also contribute to the societal problem of millions of people enrolling in college who either complete worthless degrees or never finish.

All those consequences are problems that Washington really should worry about. But that’s the other thing about a crisis: It’s usually only embraced when it means giving stuff away to buy lots of votes.

As it’s an election year it looks increasingly likely that the country will have to eat the $6.7 billion cost of an extension to the subsidized loans. When the planned extension runs out next year, perhaps then there will be the political will to deal with the issue properly.

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