Congress May Link Student Loans to Variable Rates

For students with loans to pay off, times have never been better. And they may never be this good again.

Rates on federal student loans have fallen to around 3 percent - a 35-year low. Even better, students can lock in those rates, potentially saving thousands of dollars by ensuring their payments won't increase even if interest rates do.

But a proposal in Congress could shut down the party. The measure would end the fixed-rate option, making all federal student loans (search) issued after July 2006 subject to variable rates. Repayments would then rise and fall each year in sync with interest rates.

The change - just one part of the reauthorization of the mammoth Higher Education Act (search) now wending through Congress - is intended to shift federal subsidies away from those who already have a degree, freeing up money for programs targeted at students who may be struggling to get to college at all.

The proposed change has split both Democrats and Republicans on the House Education and Workforce Committee. Chairman John Boehner, R.-Ohio, and Rep. Rob Andrews, D.-N.J., have introduced different versions, but others members oppose the proposal. Presumed Democratic presidential nominee Sen. John Kerry, has also criticized it, saying variable rates would harm students and enrich lenders.

Education groups are also divided. The United States Student Association (search) opposes the idea, but supporters include, along with lenders, the National Association of Student Financial Aid Administrators (search) and College Parents of America (search).

"This is the most visible and contentious issue in the reauthorization," said Terry Hartle, senior vice president of the American Council on Education (search).

His group supports variable rates (search) but wants the rate capped at 6.8 percent. The current proposal would keep the existing cap of 8.25 percent.

The debate comes amid growing anxiety over college costs and student debt. Figures released last week by the Department of Education show the share of full-time college students who borrowed to pay for college rose from 30 percent in 1990 to 45 percent in 2000.

An estimated 7 million Americans receive more than $50 billion in federally backed student loans each year. For the average undergraduate borrower graduating this year, a variable rate loan would cost an extra $3,000 over 10 years, the Congressional Research Service (search) estimated.

Yet when rates are falling, variable rates are good for borrowers. The CRS also found that in 13 of the last 18 years, average borrowers would have been better off with a variable rate - sometimes by as much as $4,000 over the course of a loan.

Backers of the change say variable rates also are more fair. All borrowers would pay the same rate, whether or not they were lucky enough to graduate and consolidate in a year when rates were low.

The government began allowing students to consolidate loans in 1986 as a convenience that would let them make a single monthly payment. But as interest rates have fallen in recent years, it has become a popular way for students to refinance debt at a cheaper rate.

That, in turn, has made the program more expensive for the government, which offers lenders a guaranteed rate of return. Millions of students have consolidated at low rates, forcing the government to pay lenders the difference.

A recent General Accounting Office (search) report estimated that, simply on loans issued in 2003 under one of two major programs, subsidies would amount to $3 billion, up from $1.3 billion on loans issued in 2002.

Experts differ, however, on which option would cost the government more in the long run.

Supporters of the proposed change would rather see the subsidies go to other new initiatives, like limiting students' upfront loan payments and extending borrowing limits for the first two years of college. The proposal would also require lenders to return some earnings on student loans to the government.

"It's all about reshuffling the resources within the deck and making sure low-income students who are in danger of not receiving a college degree are put back at the front of the line," said David Schnittger, a spokesman for the House committee.

But opponents say the challenge of paying off loans doesn't disappear once a degree is in hand - especially for those pursuing careers in public service.

"To add on another $3,000, $4,000 even $5,000 to interest costs to somebody who is starting out as a teacher is not a minor event for that individual," said Rep. George Miller, D.-Calif., the committee's ranking Democrat.

Supporters say they recognize the debts carried by graduates are a problem. But they say students never making it to college in the first place is a bigger one.

Said Jim Boyle, College Parents of America's president: "In a situation where there's a zero-sum game going on when it comes to budgets for higher education, our group wants to see money allocated to current and future college students, not to those who have already graduated."