Home > 2012 > Students

Why Gov’t Doesn’t Need to Raise Student Loan Rates

Advertiser Disclosure Comments 0 Comments

I worked in Manhattan many years ago—at a time when 3-Card Monte was the hot ticket on the streets. As good as you thought you were at eyeballing the elusive ace that danced from palm to palm, you weren’t. And as much money as you expected to win, you walked away with that much less.

I’m reminded of this street scam as I listen to the debate over the Direct Subsidized Stafford Loan rate that’s set to expire in July. According to the news feeds, extending the 3.4% interest rate would cost taxpayers $6 billion per year. On the other hand, allowing it to expire will shift that cost to the students who are counting on the support.

But will the feds actually lose $6 billion for every year that the subsidized program’s reduced rate is in effect, or will the government just be making a little less profit?

The truth is the ace that’s shuffling back and forth on the card table. Slow down the action and you just might be able to catch it.

Banks, finance companies and even the government (when it operates as a lender) make money by borrowing it from one group and lending it to another—but not before marking it up to cover costs and a desired level of profitability. This markup is referred to as “spread.” It represents the difference between what a lender charges to its customers (“yield”) and the price of the money that it borrows to make the loan (“rate”).

Behind the scenes, rates are indexed to a given loan’s “half-life.” At the risk of oversimplification, half-life is roughly the duration of a loan divided by 2. So a fully amortizing 10-year loan has a 5-year half-life and a 14-year loan has a 7-year half-life. That 7-year half-life is a reasonable proxy for the standard government student loan program that spans 10 years of repayment after 4 years of borrowing (which occurs while the student is in school).

With that in mind, take a look at the Markets tab on Bloomberg.com and focus on the 10-Year U.S. Treasury rate. That’s right, it’s just over 1%. So each incrementally borrowed dollar that’s needed to fund the loans the government is making today—subsidized and unsubsidized alike— costs just over 1%. But that’s not all there is to it.

The government incurs unique costs for the subsidized program because it’s paying the interest on the money needy students are borrowing while they’re in school. Assuming the annual loan limits that are detailed on the Federal Student Aid site, this program feature costs the government approximately one-half of 1% over the life of the loans it gives. That means instead of 3.4%, the government’s yield on these loans is actually 2.9%, before the expenses described below.

The government incurs administrative costs to service its loans for as long as they’re on its books. These costs cover accounting, record keeping and reporting; collections-related activities, such as for delinquent payments and restructures; and customer service-related activities, including payment processing and data modifications. In a loan portfolio the size of the government’s, it would shock me if these costs would diminish spread by more than 1% over average duration. That means instead of the 2.9% yield that I calculated above, the government is actually realizing 1.9%—still more than its 1% cost.

As for the rest of the expenses associated with operating this program, just as it is with other finance companies (including the ones I’ve owned and run) I’m going to assume that the 1% fee the government charges upfront for the loans it originates is sufficient to offset what it costs to process the paperwork. I’m also going to assume that the late payment fees it charges are sufficient to offset the financial cost of managing delinquencies.

So when you put all the pieces together, it appears that the government is yielding a little less than a 1% interest rate spread on the loans that it makes under the subsidized program and a little less than a 1.5% spread on those under the unsubsidized program, which inspires me to ask:

If higher education is in the nation’s best interest and if the government has the ability to lend money to its citizen students at an exceedingly affordable price that more than covers its cost, then why are we arguing?

This story is an Op/Ed contribution to Credit.com and does not represent the views of the company or its affiliates.

Image: ZioDave, via Flickr

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Certain credit cards and other financial products mentioned in this and other articles on Credit.com News & Advice may also be offered through Credit.com product pages, and Credit.com will be compensated if our users apply for and ultimately sign up for any of these cards or products. However, this relationship does not result in any preferential editorial treatment.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Our Owners

Credit.com is owned by Progrexion Holdings Inc. which is the owner and administrator of a number of business related to credit and credit repair, including CreditRepair.com, and eFolks. In addition, Progrexion also provides services to Lexington Law Firm as a third party provider. Despite being owned by Progrexion, it is not the role of the Credit.com editorial team to advocate the use of the company’s other services. In articles, reporters may mention credit repair as an option, for example, but we’ll also be sure to note the various alternatives to that service. Furthermore, you may see ads for credit repair services on Credit.com, but the editorial team isn’t responsible for the creation or implementation of those ads, anymore than reporters for the New York Times or Washington Post are responsible for the ads on their sites.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team