The student loan interest rate legislation that cleared the Senate in the early days of July has sailed through the House as HR 1911 in a bipartisan effort to close this issue out. Once Obama rubber stamps it – which is fait accompli – the deal is done. But the question remains is it a good deal or a raw deal for student borrowers? Here’s a look at the numbers.
We wrote on the 19th after the Senate first approved this market-driven “solution” that it’s good news for now, but likely bad news for later if the experts have it right on T-note rate rises. One thing that’s a really drastic shake up is that no longer will the government subsidize student loan interest for lower income students. Prior to July 1st, subsidized student loans were charged 3.4% interest while unsubsidized rates were 6.8%. After July 1st, rates for both types of loans leveled out at 6.8%.
Subsidized versus Unsubsidized
At a glance, the rates for 2013 are promising at 3.86% which is the 10-year Treasury note yield plus 2.05%. So how does this compare to subsidized loans issued at the 3.4% rate? See the chart below. For those who were eligible for subsidized loans, the monthly payment increase is a modest 2% and the overall increase interest charges are 13%.
If you have to go on an extended payment plan due to hardship, a 25 year repayment will see you pay 5% more each month and 13% in interest. These increases aren’t too bad for lower income borrowers and are a huge win for unsubsidized borrowers that will benefit from a 13% drop in monthly payments and a 46% drop in interest paid on a 10 year plan. Sounds good right? Read on…
Rate Increases Projected by 2015 Will Sting
Experts predict that by 2015, the T-note yield will jump to 4.9%. This is where the financial situation turns on its ear and becomes much more challenging. Under the 10 year standard plan, all undergraduate borrowers will be paying 6.95%. This is drastically higher than the 3.4% subsidized rate enjoyed by low income borrowers up until June 30th of this year and marginally higher than the current unsubsidized rate.
The increase in monthly payments from $295 to $347 is a 15% leap, but the interest increase is more significant. On a 10 year payment plan, interest paid will more than double from $5,430 to $11,706. If you have to stretch it out to 25 years, the difference in payments is a whopping 30% going from $148 up to $211 and interest similarly more than doubles. For the 3.4% on a 25 year plan, interest would be $14,575 compared to $33,322 on the market-based plan.
Rate Rises Projected by 2017 Will Push the Legislative Cap
For undergraduate loans, the new law caps the interest rates at 8.25%. By 2017, market experts predict a jump in T-note yield to 6.5%. With the 2.05% upcharge, this would push the interest rate to 8.55% were it not for the interest cap! So how does hitting the cap play out comparatively for student loan borrowers who would have been able to access a 3.4% rate under expired legislation?
With the same $30,000 in loans we’ve been using for the sample calculations, under a 10 year plan, monthly payments would be 20% higher going from $295 to $367. Total interest would jump from $5,430 to $14,154 – a 62% increase. If you need to pursue an extended plan, the monthly installment would grow from $148 to $236 – a 37% increase. Interest paid would increase 64% from $14,575 to an incredibly unaffordable $40,957!
**Obviously because you borrow over a period of years, each loan would carry a different rate and you will likely have different loans at several different rates. Our examples are a simplification assuming one consistent rate for the entire loan term for ease of comparison.
What Can Be Done?
For now, since the legislation just gained passage in both houses of Congress and has been promised a thumbs up by the White House, it’s a done deal. And so long as the rates stay reasonably close to current rates, there will be little to complain about. But within two years, we could be on the brink of another crisis that will hopefully force a reconsideration of this legislation and a look to a better plan. And what’s important to note is that this legislation does nothing to address the overarching student loan crisis and much-needed reform. It doesn’t help all those already in debt who are struggling. This must not be forgotten!
To get a grip on your personal student loan situation, sign up for Tuition.io’s free student loan tool to see all your loans – public and private in one easy to understand dashboard. You can also try on repayment plans for size and contact your lenders. Also check out our blog for strategies on tackling your debt!