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By Christine Benz | 04-15-2013 12:00 PM

Future of Student Loan Rates Unclear

Debates in Washington continue about interest rates tied to student loans, and college savers face more headwinds as states reduce university funding.

Christine Benz: Hi. I’m Christine Benz for Morningstar.com. The interest rate on a popular student loan type is set to go up at midyear, barring congressional action. Joining me to discuss this and other college-funding news is Adam Zoll. He is assistant site editor for Morningstar.com. Adam, thank you so much for being here.

Adam Zoll: Thanks for having me.

Benz: We're set to see the subsidized Stafford loan rate jump up from 3.4% currently to 6.8% at midyear, barring congressional action. Adam, let’s talk about what is a subsidized Stafford loan?

Zoll: A subsidized Stafford loan is a loan available to students from lower-income families who demonstrate a financial need to pay for college. It affects more or less about 9 million students per year.

Benz: So it would affect already-existing loans or just new loans?

Zoll: This would only affect new loans for the upcoming school year. Existing Stafford loans would still be at their current rates.

Benz: Now, Adam, the president's recent budget proposal also included some proposals regarding student loans. Let's talk about what was in there.

Zoll: Sure. What's really significant about the president’s proposal is that for the first time it would tie student loan rates to market-based rates. Previously these rates were set by Congress. What the president is proposing is to use the 10-year Treasury note yield as sort of a basis for calculating these other loan rates. So the subsidized Stafford loan would be about 1 percentage point above that market rate. The nonsubsidized Stafford would be 3 points above, and the Parent PLUS loan would be 4 points above. So for the first time these student loan rates would be more in sync with overall interest-rate movements.

Benz: So they'd float along with the prevailing interest-rate environment.

Zoll: Right. It’s important to know, they would change year by year, and they would be fixed [to interest rates] for the life of the loan. So they are not a variable-rate loan. But the rate would change year by year based on what the market is doing.

Benz: So right now that actually might be a good thing for people taking out these loans; the rates might actually be lower than where they are at 3.4% and 6.8% currently. But if rates trend upward, that could become a problem.

Zoll: That’s the concern of people who are critical of this plan, is that once rates do start to rise, students and their parents could end up actually paying higher rates than the rates set by Congress. So that's a real concern.

The response to people in the president’s proposal is that the income-based repayment structure would be broadened, so that students would not be required to pay more than 10% of their discretionary income in a given year to repay these loans, and then there would be a 20-year cap as long as people stay good on their loan repayments. So the argument is that that would have sort of an effect to reduce the impact of potentially higher rates. But it’s an interesting argument back and forth. Tying these loan rates to the market does have Republican support, so it’s a case where the president and the Republicans are on the same side. So it would seem to give this proposal some legs of possibly happening.

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