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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Aug 1, 2013

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On July 24, the Senate voted 81 to 18 to lower federal student loan interest rates on Stafford loans. The previous rate of 6.8 percent — which was brought into existence on July 1 due to Congressional inaction — has now been reduced to 3.86 percent.

The new rate not only applies to student loans taken out in the future, but it will apply retroactively to all financing taken out after July 1, 2013.

This agreement is not beneficial for everybody though, as graduate federal student loan borrowers and parent PLUS borrowers will now see increased rates of 9.5 percent and 10.5 percent, respectively.

The Senate agreement will also transition federal student loan interest rates into a market-based system. Following the 2015 academic year, fixed interest rates will be tied to 10-year Treasury notes.

In order to limit the amount of interest that federal student loan borrowers will be paying on their treasury-tied financing, the agreement caps interest rates at 8.25 percent for undergraduates, 9.5 percent for graduate students and 10.5 percent for PLUS loan borrowers.

Experts who spoke with have mixed reactions to the Senate’s deal.

A Bad Deal for Student Loan Borrowers

Unsurprisingly, several of these experts voiced disappointment and outrage at the Senate’s student loan deal, despite the fact that it has yet to be passed into law.

Marie Patterson, Vice President of Marketing for Hiperos, said that with the total outstanding student loan debt in the U.S. hitting $1.2 trillion and complaints lodged with the CFPB exceeding 6000, this deal will save borrowers some money but it is still not addressing the underlying problems that regulators have only just begun to notice.

“Like any other type of consumer financing, regulators are increasingly concerned about potentially fraudulent or predatory practices,” she said. “We are starting to see and expect to see greater oversight from regulators in this area, particularly in terms of how banks and other non-banking financial institutions manage their 3rd parties and any sub-contractors involved in any part of the student loan process.”

Since the new plan will tie interest rates to Treasury yields, this increase in oversight is coming at a welcome time.

The Executive Director of the California Student Aid Commission, Diane Fuentes-Michel, said that while the Stafford loan interest rate reduction is beneficial for student borrowers, it is a compromise measure.

Her assessment is proven by the slow nature of Congress’ decision making process since it has taken virtually an entire month to formulate the agreement. Now, the student loan plan heads towards the House, which may or may not take the same amount of time to deliberate the agreement’s merits.

With coming Congressional elections in 2014, Fuentes-Michel knows that new politicians and policies can shift the Senate’s student loan agreement, as can the anticipated reauthorization of the Higher Education Act in the fall. As with nearly all forms of legislation, nothing in set in stone.

Congress, far from willing to act on its own volition, was pressured by students’ outcries, according to Fuentes-Michel. With such outcry, Congress may have passed an even worse deal for students.

Despite the ruckus that some politicians have made over the federal government allegedly earning $200 billion from student loan borrowers, Fuentes-Michel is fine with such profit provided that it is reinvested into need-based federal aid and into the Pell Grant program. Doing so will allow more students to pay for college without needing to work a second job or take on additional debt.

One expert just flat-out opposes the Senate’s deal.

“It is very difficult for college students and graduate students to continue their studies in the economic environment in which we currently live,” said Bettina Seidman, Career Management Coach at SEIDBET Associates.

The cold hard facts of underemployment and unemployment for Millennials proves Seidman’s assessment true. Despite the ongoing economic recovery, recent graduates still face difficult career opportunities.

Still though, Seidman gave the government its due credit for assisting students and parents by making college more affordable, albeit now at variable interest rates. She fears, however, that these interest rates will rise and force students to postpone career choices, thus bringing a further strain on the economy’s ability to thrive.

While Seidman and other experts raised valid concerns about the Senate’s deal, other experts praised the agreement’s success and the action of the Senate to lower student loan interest rates. 

The Senate Saves the Day

Ting Pen, Co-Founder of ValuePenguin, thinks that the Senate’s proposal is actually a solid deal.

“The deal provides clear and transparent direction on how student loans’ interest rates will be determined, with the added benefit of a ceiling on interest rates so that upward exposure is capped,” said Pen.

Pen does have a point in that while the new policy for student loans allows their interest rates to increase, there is a cap on how high rates can climb.

Despite the fear of interest rates being able to rise in accordance with 10-year Treasury notes, Pen thinks that the economy is currently in a low-interest environment. He does warn that as the economy rebounds, the benchmark Treasury yield will rise, thus prompting an increase in interest rates that will inch closer to the cap.

One expert praised the Senate plan yet compared it to a double-edged sword.

Robert Farrington, Founder and Editor-In-Chief of the College Investor, believes that it is possible the Senate’s agreement will both hurt and help federal student loan borrowers.

“For responsible borrowers that are going into well-paying careers, this is going to help them,” he said. “The lower interest rates for the next few years will make it easier to repay their loans.”

However, irresponsible student loan borrowers were going to struggle, regardless of any policy decisions made by the government. One example Farrington used was a student paying $50,000 for an art degree that would be difficult to repay no matter what the interest rate was.

Also, colleges and universities, the prime parties responsible for increasing tuition year after year, would be unaffected by the new agreement.

In Farrington’s view, college and university financial aid offices function like used car lots. Their sole goal is to get students to borrow student loans. He doesn’t see this situation changing until students and parents view their expected return on investment for their degrees and student loan debt. Worse still is the fact that Senate deal or no Senate deal, student loans still cannot be discharged.

“Even though there is a 35 percent delinquency rate on student loans, the repayment rate is still about 98 percent,” he said. “The reason? Student loans can never be discharged, and the lenders will get their money back through garnishment and other recourses. So, high loan rates won’t impact lenders or universities, just students who borrow more than they should.”

Another factor that Farrington thinks will trigger a cost increase for student loan borrowers is that Treasury interest rates are expected to increase past their current historical lows. Naturally, they can only increase in one direction: Up.

“However, I view that as a good thing,” said Farrington. “Students and borrowers need to be smart about how much they borrow, and smart about where they spend that money.  Hopefully, more pain in repayment will help students make better decisions.”

One expert already in pain is Jill Silos-Rooney, Assistant Professor of History at MassBay Community College. “Travesty” is the word that came to her mind when she learned of the Senate’s deal.

“Tying student loans to the market is a way for others to make a fast buck, not a way to create a stable economic structure with long-term growth,” said Silos-Rooney. “Students will be so swamped with debt that they will be unable to contribute to the consumer economy through home, car, and other big ticket purchases — which is the foundation of the American economy.”

Even the CFPB has determined that high student loan debt, which will only become more a threat as interest rates rise, dampens the economy’s ability to grow as indebted borrowers delay necessary purchases that stimulate economic activity.

A student loan borrower herself, Silos-Rooney, along with her husband, have been forced to delay buying a home since their student loan debt is so massive. Each month they pay in excess of $1500 just in student loan payments.

The Senate’s deal is now headed to a vote of approval before the House of Representatives. If passed, it will proceed to the President’s desk for a signature of approval.