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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Jun 28, 2013

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In three short days, the interest rate for subsidized federal student loans will double. American citizens of all ages have protested against the increase, and petitioned for change, but nothing has been approved yet.

Many groups have suggested fixes for the loan program, but two of the main proposals focus on either extending the interest rate for two more years, or linking the rates to yearly market values.

Both proposals have positive and negative impacts on borrowers and the general economy as a whole. Since a plan has not been approved yet, the future is uncertain. Sometimes in order to understand the impact of these potential changes, it can be important to look back into history.

Average Student Loan Interest Rates from 1965-2013

Academic Years Repayment Interest Rate (%)
1965-1968 8.00 fixed
1968-1981 7.00 fixed
1981-1988 9.00 fixed
1988-1992 10.00 fixed
1992-1993 6.94
1993-1994 6.22
1994-1995 7.43
1995-1998 8.25
1998-1999 7.46
1999-2000 6.92
2000-2001 8.19
2001-2002 5.99
2002-2003 4.06
2003-2004 3.42
2004-2005 3.37
2005-2006 5.30
2006-2008 6.8
2008-2009 6.0 for subsidized Stafford, 6.8 for other loans
2009-2010 5.6 for subsidized Stafford, 6.8 for other loans
2010-2011 4.5 for subsidized Stafford, 6.8 for other loans
2011-2012 3.4 for subsidized Stafford, 6.8 for other loans
2012-2013 3.4 for subsidized Stafford, 6.8 for other loans

When the federal government decided to offer federal student loans in the 1960s, the interest rates were fixed at 8.00 percent. The rates fluctuated up and down, but they remained fixed up until the early 1990s.

The only time that student loan interest rates were not fixed, and were linked to the short-term U.S. Treasury rates, was between 1992 and 2006.

Interest rates decreased alongside the market until they became fixed at 6.8 percent in 2006. Due to the escalating cost of student loan debts, ways to reduce borrower costs were devised.

House Democrats wanted to reduce the interest rate for federal student loans. Opponents of the plan estimated that the rate cut to 3.4 percent for students and 4.25 percent for parents would cost $52 billion over five years. This cost would expand to $133 billion over a decade.

This large cost negatively affected the Democratic campaign that year, so a bill was passed with significant changes to the original plan. It was called the College Cost Reduction and Access Act of 2007.  The interest rate reduction would only be offered for one type of loan: the subsidized Stafford loans, which are for families in the low-to-middle income bracket. For this small group of federal student loans, the interest rate was reduced from 6.8 percent to 3.4 percent.

The House of Representatives and the Senate signed a budget bill which changed the interest rates in September 2007. An extension was made in 2012, but it is set to expire on July 1, 2013 unless another plan is devised.

The reason why the bill must be changed is due to fiscal concerns about the government deficit. Increasing the interest rate, or setting the rate to fluctuate with market values, will bring in more revenue for the federal government at a time it desperately needs help. One more year of 3.4 percent interest rates, instead of setting the rate at 6.8 percent, will cost taxpayers $8.3 billion.

Despite a large cost to taxpayers, most coverage focuses on the potential cost to student loan borrowers.

Eric Greenberg, founder and president of the Greenburg Educational Group, told that the potential doubling of the interest rates will further spike tuition costs and prevent more students from being able to afford an education.

He said that 58 percent of student loans are held by people in the bottom 25 percent net worth category.

“Given how many people do take out subsidized loans, it is definitely very significant,” Greenberg said. “The people who need the loans the most are the ones most affected.”

Now that history is behind consumers, both the President and the House of Representatives needs to decide what to do about this approaching issue.

There are many different proposals for how to solve this approaching issue, but two plans outweigh all of the others. One leaves room for skyrocketing rates and one simply extends an older plan.

The First Plan: Link Rates to Market Values

The House Republican plan offers the most risk out of the two main options. The plan would reset the yearly interest rates based on market conditions.

The market interest rate would be set each year, so although borrowers would not experience shock each month, their rates could increase each year, adding or subtracting from a strict repayment plan. This can cause problems for the borrower who can no longer budget exact payments for their loans.

This plan is touted by House Speaker John Boehner. On June 18, he wrote a letter to President Obama requesting that House Democrats accept one plan to fix the student loan issue. He said that the Democrat’s “unwillingness to follow Obama is the only thing stopping this solution.”

“I urge you, as president and leader of your party, to compel your Democratic colleagues to pass a market-based student loan bill,” he wrote.

Although this could offer borrowers historically low rates now, it could also force borrowers to pay up in the near future when interest rates grow. It leaves a large variable for borrowers.

In order to compare the potential cost that student loan borrowers would have to pay, let us consider two debt increments: $15,000 and $35,000. The average repayment term for subsidized Stafford loans is 10 years. Using a student loan calculator, found what impact potential rate increases could have on borrowers’ monthly payments.

Market-Linked Plan for Subsidized Stafford Loans – $15,000 Debt

Possible Future Market Interest Rates Monthly Payments on $15,000 Debt
2.5% $141.40
4.5% $155.46
6.5% $170.32
8.5% $185.98

Market-Linked Plan for Subsidized Stafford Loans – $35,000 Debt

Possible Future Market Interest Rates Monthly Payments on $35,000 Debt
2.5% $329.94
4.5% $362.73
6.5% $397.42
8.5% $433.95

Although low interest rates this year and next year could assist borrowers, the likely increases in the market could begin to strain borrowers. In 2012 and 2013, market interest rates were near historic lows. But if borrowers refer back to historical changes as recent as the early 1990’s, the interest rates for student loans surpassed 8 percent.

If the interest rate is set at market value, it will take advantage of the current low rates. But opponents of this plan fear not for current borrowers, but what will happen next year, and the following year. Since the market is unreliable and constantly changing, interest rates could increase drastically in a short period of time.

The plan for market-linked interest could allow a borrower to pay only $141.40 on a $15,000 loan initially, but if the market swings up to 8.5 percent, the same borrower could face monthly payments of $185.98.

The same goes for the borrower with a $35,000 debt. A low rate of 2.5 percent will enable their monthly payment to remain relatively low at $329.94, but an increase to 8.5 percent will cause that same payment to spike to $433.95.

Greenberg said the price differences can be very significant for some people.

Although the rates could skyrocket, Greenberg does believe that setting student interest rates to the market is a sensible plan.

He said that political ramblings will be reduced if the rates are linked in this way.

“It has become political because Washington has set the rates. If this was on a metric, this wouldn’t happen,” Greenberg said. “This whole crisis issue would be less likely to occur.”

The only caveat to this plan is to set an interest rate cap so the rates cannot exceed a certain amount. Without a cap, borrowers would likely fear the cost even more and might avoid higher education.

“If there was no cap on it, it could make it much more difficult for the student to decide to make the plunge,” Greenberg said while comparing student and mortgage loans. “I know a lot of people that would not be willing to sign a mortgage if there wasn’t a cap.”

Plan 2: Continue the Low Rates

The other popular plan would extend the current interest rate on subsidized Stafford loans for two more years. The proposal, suggested by Sen. Tom Harkin, Sen. Jack Reed, and Senate Majority Leader Harry Reid, is a simple plan of inaction and relies on the House devising a better plan of action in the near future. It is similar what occurred a year ago when the interest rates were set to increase on July 1, 2012.

For this proposal, interest rates would remain similar for borrowers with subsidized Stafford loans. In order to highlight several monthly payments, refer to the table below. 

Interest Rate Extension Plan for Subsidized Stafford Loans

Total Student Loan Debt Monthly Payments with Fixed 3.4% Interest Rate
$5,000 $49.21
$15,000 $147.63
$25,000 $246.05
$35,000 $344.46

Interest rates for these loans have been set at 3.4 percent since 2011. They did assist borrowers who struggled with the economic crash in addition to repaying their student loan debts. But now that the overall economy is improving slowly, the government should be open to raising the rates as well.

Greenberg disagrees that extending the rates will harm the economy. Although economists predict that it will cost the government billions to extend this low interest rate, he said that this is only true “in a vacuum.”

“I think the cost of doing it will be greater because of the cost on the economy,” he said.

Greenberg said that increased rates will actually harm the economy by reducing disposable income and impacting the educational output of students. If fewer students can afford a degree, our population could become less educated. If the rates are increased, it could have a “ripple effect” on the economy.


The two plans outlined are only part of the entire picture. Many state representatives and Senators have suggested their own plans of action, but a consensus has not been reached.

There are multiple options and no solutions yet. Since Congress is on recess for a week, Greenberg said it is unlikely that a decision will be made before Monday. He said if any decision is made, it will likely be retroactive. Borrowers that take out loans after July 1 will be able to access the benefits of the new agreement.

Although news coverage focuses mainly on the subsidized Stafford loans, Greenberg is worried about the impact of a rate increase on other forms of private and federal loans. If one aspect of the student loan industry raises rates, others could follow.

“The effect might not only be on that chunk on the subsidized student loan that the student has,” he said. “It could cause private lenders to raise the rates.”