How Student Loans Subsidized the American Dream
On July 1, the rate of a subsidized Stafford student loan doubled to 6.8 percent from 3.4 percent, after Congress shut down for the Independence Day holiday without taking action to prevent a scheduled increase. If lawmakers fail to reach a retroactive agreement before the August recess, the average Stafford borrower will have to pay back about $800 more than under the previous rate for every year of loans.
Today, about 66 percent of students borrow to attend college. For 2011-2012, 10.4 million borrowers took out $85.9 billion in Stafford loans, for an average of about $8,200 per borrower. In the past 50 years, more than 60 million Americans have used student loans to pay for college.
In 1950, only 5 percent of Americans age 25 or older held bachelor’s degrees. Today, that figure is 31 percent. This explosion in attendance -- along with periods of inflation, higher costs, state-level taxation policies and several other factors -- has contributed to rising tuition and enrollment expenses. The supply of university slots has increased, but not enough to meet demand.
Those higher costs required new ways of paying for postsecondary education. The federal government began its programs in 1958 through the National Defense Education Act. That measure established what would become Perkins loans, a need-based system that pinned interest rates at 5 percent and provided affordable loans for college to former soldiers and other eligible students.
In 1965, the Higher Education Act allowed the federal government to offer more student financial assistance through the Federal Family Education Loan Program. It expanded Perkins loans and introduced Stafford loans that were guaranteed by the federal government, which paid the interest that accrued during a student’s time in college and paid the difference between a set low rate and the market rate after graduation. In today’s terms, when the government pays the interest while the borrower is in school, the loan is considered “subsidized,” and when it doesn’t, that loan is “unsubsidized.”
The government entered into a number of partnerships with private companies to service and originate these loans, bringing private student-loan creditors into the market. In 1972, the government reauthorized the Higher Education Act and created the Student Loan Marketing Association, a government-sponsored enterprise known as Sallie Mae.
In the late 1980s, members of Congress and the Education Department pushed for a system of loans under which the government would originate and service student loans, which would eliminate the expense of the fees that private lenders charged student borrowers.
President Bill Clinton signed the Federal Direct Loan Program into law in 1993. The measure required the federal government, and not the government-sponsored enterprises, to originate the loans. However, the following year Congress enacted a law that didn’t require all loans to originate through the Federal Direct Loan Program.
Many students didn’t pursue the program’s financing because heavy lobbying and marketing by private student-loan companies succeeded in perpetuating the old system of using government-sponsored enterprises and private creditors to service government-secured loans. In the 1990s, the Federal Family Education Loan Program provided $215.3 billion in student loans, while the Federal Direct Loan Program provided about $60 billion.
In 2010, the federal government passed the Health Care and Education Reconciliation Act, which made the Federal Direct Loan Program the only government-backed one, eliminating the Federal Family Education Loan Program. The federal lender and the student borrowers could save the money that was going to the government-sponsored enterprises, about $6 billion a year.
For most of the past 60 years, all lenders tied student-loan interest rates to the prime rate or the 10-year Treasury yield. In 2007, Congress passed the College Cost Reduction and Access Act to temporarily lower student-loan rates during the recession. It eliminated the variable rates of Stafford loans, and instead set unsubsidized loans at 6.8 percent and subsidized loans at a lower, somewhat variable, rate.
Last week, Congress was unable to reach an agreement to continue that reduction. Lawmakers were unable to choose between two plans that both tied interest rates on subsidized Stafford loans to the 10-year Treasury rate. One of the plans would add 1 percentage point to that rate, and allow students to lock it in over the life of the loan. The other would let interest rates float every year, like adjustable-rate mortgages, but with a minimum rate of about 5 percent and a ceiling of about 8 percent.
From the mid-1990s to 2007, student-loan rates were set somewhere between 0.5 percentage point and one percentage point less than the prime rate, which is currently 3.25 percent. This generally gave student loans higher interest rates than the 10-year Treasury note, now at about 2.5 percent.
That means neither of the plans represents a radical departure from longstanding practice. The real question is whether there is something different about today’s environment that warrants ending 60 years of low student-loan rates. College is certainly more expensive, both in real and nominal terms. More people are determined to attend, and many of them don’t have the resources to pay on their own. The government has already bought into the idea that a college education is central to the American dream; now it must decide how much students should pay for it.
(Lawrence Bowdish is an adjunct professor of history at American Military University. He has written on student loans and on consumer credit in “The Development of Consumer Credit in Global Perspective: Business, Regulation, and Culture.”)
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