Just before they left town for the July 4th break, members of Congress finally voted to prevent a doubling of student loan interest rates for one year with mere hours to spare. Unfortunately, they paid for it by reducing other educational programs. If we want an educated workforce in the future, we need more permanent fixes to make college affordable for Americans.
Although Congress maintained lower rates for subsidized loan recipients, members altered repayment rules so that recent graduates will have higher repayment bills. Prior to the passage of the interest rate cut extension, interest on loans did not accumulate until six months after graduation. Starting in 2014, interest charges will begin accruing the day after graduation. The recent generation of graduates has already been hit hard by the Great Recession; the underemployment rate for recent graduates is more than 19 percent.
On top of all this, access to federal lending has been narrowing. In 2011, as part of the debt ceiling deal, Congress voted to deny graduate students subsidized student loans, and last week's compromise will do the same for some non-traditional students by limiting subsidized student loans to only six years of undergraduate study. Non-traditional students, who often take more than the normal four years to graduate, are among those most in need of financial aid.
The cost of college has been increasing at a rate faster than inflation since the 1980s, and costs have skyrocketed in the past six years (see Figure 1). Controlling for inflation, annual tuition at private schools nearly tripled from $10,144 in 1981 to $28,500 in 2011-12 (a 181 percent increase). Average costs at public universities almost quadrupled, from $2,242 in 1981 to $8,244 last year (a 268 percent increase).
Sixty years ago, in 1952, the cost of a four-year undergraduate degree at the University of Pennsylvania was just $6,280 ($54,462 in today's dollars), including room and board and books. That's less than a single year at UPenn today, which costs $59,600 a year (including room and board and books). Leading educational researchers are warning that this trend is pricing many students out of higher education.
Unsurprisingly, the increase in the cost of a degree is translating into more debt for students. Almost half (47 percent) of students in 2007 received some form of financial aid, up from 32 percent fifteen years ago. And the average loan amount borrowed per student has been rising; it is now over $8,000 a year (see Figure 3). Recently, the total amount of student debt rose to over $1 trillion, eclipsing the amount of credit card debt. This represents a permanent drag on individual savings and investments. Keeping interest rates on this debt down is important but doesn’t solve the underlying problem.
Federal loan interest rates have fluctuated dramatically over the past 30 years, as the Reagan administration raised rates, pegged them to the prevailing rate for Treasury bonds, and encouraged private banks to get involved in the student loan market. From the 1960s, when Congress created the federal student loan program, through 1992, Congress fixed the interest rate at between six percent and 10 percent. In 1992, Congress voted to shift to a "floating" rate, setting loans at 3.1 percent higher than the prevailing rate for short-term Treasury bonds (with a nine percent rate cap). Congress did not revert back to a fixed interest rate formula until 2002, when it passed a law that set a 6.8 percent rate for new loans. This rate went into effect in 2006.
After Democrats won control of both houses of Congress in 2006, they made good on a campaign promise and halved the student loan rate to 3.4 percent. But, as they had also pledged to follow Pay-As-You-Go (PAYGO) budgeting principles, they narrowed the loan program dramatically. Instead of cutting all rates, they just reduced rates for a subset of federal student loans – subsidized federal loans for undergraduates, and they phased in the reduction over a number of years. The new rates were set to expire after five school years in order to reduce the long-term PAYGO budget score for the legislation. This expiration was scheduled to take place this summer, but last week, Congress voted to keep loan rates low for another year.
The way that the government subsidizes a college degree has undergone a substantial shift in the past 70 years. After World War II, the nation's signature education initiative, the G.I. Bill, helped more than a million veterans pay for higher education with direct grants, which did not have to be paid back. Today, student loans are by far the bulk of federal dollars spent on undergraduate students. In 2011, $70 billion of undergraduate student aid was provided by federal loans, more than twice the amount given through Pell Grants. About 500,000 veterans use educational benefits every year (compared to 10.3 million students who receive federally guaranteed student loans).
Loans help spread limited federal education dollars, but piling debt onto students is a drag on the economy. IHS Global Insight economist Chris Christopher notes that "People are delaying marriage, postponing having children, and taking a pass on home purchases…They're living with their parents. They're not spending as much as they otherwise would have."
Sending people to college is an investment in America that benefits everybody. Fortunately, there are a number of ways to put college within reach of more people. We could return to expanding programs like the G.I. Bill and Pell Grants, which provide direct cash assistance to students. We could pass Rep. Hansen Clarke's (D-MI) Student Loan Forgiveness Act of 2012, which would lift the debt burden for students who have repaid a good proportion of their loans but are currently having trouble staying above water. And there are ways to pay for increased college financing, from taxing risky high-volume stock transactions to cutting the $600 billion Defense Department budget.
The outlook for students trying to figure out how to pay for college is pretty bleak. The Great Recession has severely constrained the amount of money parents can contribute to their children's education funds; tuition at many state universities has skyrocketed thanks to state budget cuts, and college graduates entering the workforce face a very tough job market. Congress' action to keep student loan interest rates low was a necessary first step, but it isn’t a solution to the problem of exploding student debt.