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The Student Loan Fix That Wasn’t

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“Going forward, the whims of Washington politicians won’t dictate student loan interest rates, meaning more certainty and more opportunities for students to take advantage of lower rates.”

So spoke House Speaker John Boehner after the passage of H.R. 1911, the Bipartisan Student Loan Certainty Act of 2013. But six months after enacting a measure that ties student loan interest rates to a market-driven financial instrument, is there indeed more certainty? How about opportunity? Or, could it be that the real beneficiaries were lawmakers who desperately wanted to drop-kick a miserably contentious issue into a less than certain future?

When H.R. 1911 was implemented, undergraduate student loan rates were reset to 3.86% — a nearly 3% improvement for unsubsidized borrowers and a 0.5% bump in rate for those who previously qualified for the subsidy. Loans for graduates and professionals were pegged at 5.41%, and 6.41% for parents.

All these rates were based upon a 10-year Treasury note that yielded an exceptionally low 1.81% at the time. Hence the worry that was voiced by those who called the reduced rates unsustainable “teasers” and voted against the bill.

Turns out, the worriers were right — six months later, 10-year Treasury yields have gone up, and are hovering around 3%.

So what does that mean for borrowers? Well, if the 3% rate were to hold through May 2014, $10,000 of new borrowing would result in monthly payments that are nearly 6% higher. Even more disconcerting, the total amount of interest that would be paid over the life of that loan would be 33% greater.

The Actual Cost

There’s also another matter that hasn’t been settled.

Each of these loan rates incorporates an administrative add-on — a fee that’s expressed in interest rate form. The upcharge for undergraduates is 2.05%, 3.6% for grad-school students and professionals, and 4.6% for parents. This translates into upfront fee equivalents of approximately 10%, 18% and 23%, respectively, and it’s in addition to the 1.072% application fee for Direct Loans, and the 4.288% fee that PLUS borrowers pay.

Why such huge administrative add-ons to the base interest rate? Your guess is as good as mine, especially when the nation’s largest student loan servicing company (Sallie Mae) ascribes a scant 0.9% (0.2% in interest rate format) to the cost of servicing the $1 billion of government-guaranteed loans it securitized just a few short months ago.

Which brings me to Section 4 of the act. It calls for a “study on the actual cost of administering the federal student loan programs” — an effort that was supposed to have been concluded by the comptroller general within 120 days from the date on which H.R. 1911 was signed into law. A quick check with some folks in D.C. and it seems that the CG’s report is MIA, at least until sometime this spring.

Review Time

With all that in mind, student borrowers should hold accountable those who pledged to revisit at a “later date” the action they took in July. In fact, that later date could come sooner than those who sought to quell the critics may have anticipated.

Congress is scheduled to take up the reauthorization of the Higher Education Act in a few months. By then, the value of the administrative add-on should have been fully vetted. Also by then, the inappropriateness of last summer’s loan-pricing scheme should have become apparent.

When that happens, Congress should scrap the 10-year Treasury note-link and replace it with the financial instrument the feds are actually utilizing to fund the various student loan programs. In other words, if the government is funding these loans with sales of, say, 12-month Treasury notes, the program’s rates should also be indexed to that same instrument.

As for the administrative add-on to the interest rate, this too should only reflect the actual costs that are incurred by the government to bill and collect loan payments, manage delinquencies and cure defaults—whether directly or through its many subcontractors—and not a penny more.

That is, unless Congress intended for this to be something other than a fair deal for the students who are undertaking these enormous debts and the taxpayers who’ll have to make good on the government’s guarantees when they end up defaulting.

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

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