The Interest Rate Impact

WASHINGTON -- After weeks of warnings and stalled debate in Congress on a long-term solution, the interest rate for new, federally subsidized Stafford student loans doubled July 1. Unless Congress agrees on a new plan next week and applies it retroactively, borrowers will pay 6.8 percent interest on new subsidized and unsubsidized loans.

But it’s unclear what, exactly, that will mean for students, and whether the hubbub over the interest rate -- a debate that has confused many student borrowers who are not affected by the increase -- will affect how students attend and pay for college in the long run.

For more than a year now, the interest rate debate has been a sort of proxy for the war over college affordability in general. The subsidized rate increase does affect some of those the federal government deems least able to pay for college. 

Subsidized student loans, which go to just under half of new undergraduate borrowers, are available only to students determined to have financial need. (Unlike unsubsidized loans, available to all undergraduate students, subsidized loans don’t accrue interest while students are enrolled in college.) About three-quarters of those loans go to students from families making under $60,000 per year.

Students who borrow the maximum amount of subsidized loans -- $23,000 over a college career -- will pay about $4,000 more in interest over a standard 10-year repayment plan. The average subsidized Stafford borrower takes out much less, about $9,000, and will pay about $1,500 more over the life of the loan.

Interest rates for subsidized loans have been this high before. The rate was 6.8 percent as recently as the 2006-7 academic year, before Congress passed legislation that fixed the rate for unsubsidized loans at that level and gradually decreased the subsidized loan interest rate over five years, before allowing it to rebound in 2012. (That scheduled increase, which was delayed last year, is the root of the current interest rate controversy.)

Before that, under an older system that determined interest based on rates in the broader economy, interest rates were as high as 8.25 percent in the mid-1990s. The rate of 3.4 percent is a historic low, although supporters of lower rates point out that it’s also cheaper for the federal government to borrow money than it has been in the past.

But beyond the increased debt burden, it’s unclear how much difference the extra cost will make this time, when concern about student borrowing, and average debt loads, are higher than they were in the past. Interest rate costs affect students as they repay their loans after leaving college, not upfront, the way a tuition increase or a Pell Grant cut might. And researchers who study student financial aid and borrowing behavior say they’re unaware of any studies on whether the interest rate increase might make subsidized loan recipients less likely to enroll in college, or more likely to decline a loan.

It’s hard to draw conclusions about the effects of interest rates on borrowers' behavior based on higher rates in past years, because there could have been other changes in the intervening years, said Andrew Kelly, a resident scholar in education policy at the American Enterprise Institute. College-going rates increased as interest rates declined after the 2007 legislation, but that change is attributed to the poor economy, not to student loan policies.

And student borrowers in general aren’t necessarily well-informed about loans and debt. Some have difficulty distinguishing between loans and grants, and confusion is widespread about the differences between federal and private loans, to say nothing of subsidized and unsubsidized federal loans. More than half of high-debt borrowers in a 2012 survey from Young Invincibles said they were confused by some aspects of their loans, including the interest rates.

Given that confusion, the effect of the interest rate in particular "will probably be modest, if at all,” Nick Hillman, an assistant professor of educational leadership and policy analysis at the University of Wisconsin at Madison, wrote in an e-mail to Inside Higher Ed. Hillman said he wasn’t aware of studies looking at interest rates on student loans specifically, but the literature on student borrowers over all suggests that students aren’t well-informed enough about loan repayment -- some aren’t even aware that they will have to pay interest at all, he said -- for an increase of 3 percentage points on only some loans to have an effect.

Interest rates can make a difference in borrowing habits in other areas; people are more likely to shop around for a better interest rate on an auto loan, for example, Hillman said. But the only way to “shop around” in higher education is to look at private student loans, which will almost certainly still have higher interest rates than federal loans -- particularly for undergraduates with no credit history, and particularly for those with no co-signers.

“Poor students don’t have the luxury of shopping around,” Hillman said. “Those who were likely going to go to school will probably still enroll regardless of the rate. If there are any effects from this change, it would likely be felt by people on the margins where this small change might be enough to induce them to drop out or not enroll in the first place.”

Minority students, and those who are the first in their families to attend college, already face a disproportionate burden from loan debt, and that’s likely to increase with higher interest rates, said Jake Gross, an assistant professor of education at the University of Louisville who has studied and written on student debt.

“This is unfortunate for all students, but I think the greatest effect of the interest rate increase will be on students who already face the greatest hurdles in financing their education,” Gross said.