Rates and Rhetoric: What’s Next For Student Lending?

Interesting factors at play in higher education affect all stakeholders.


After years of debate and plenty of partisan bickering, congressional leaders drafted the Bipartisan Student Loan Certainty Act of 2013, which President Obama signed it into law on August 9. The new law changes how the government calculates interest rates on federal student loans each year and pegs interest rates against treasury bonds as set by the market. Previously, Congress haggled over rates on an annual basis.

This new law brings a reasonable long-term solution to the table. In today’s low interest rate environment, the majority of federal student loan borrowers — including parents borrowing via a federal PLUS loan — will enjoy a lower rate due to its passage. On the other hand, even with caps in place, future borrowers could pay much higher rates when interest rates rise.

The debate about federal student loan rates has dominated policy discussion for more than two years, so this new law solves the student loan problem, right? Not so fast.

Cost Control

The great rate debate made for good political theater, but it also masked the bigger problems facing student borrowers. Many observers have noted the real problem is the principal, not the interest rate. And the principal continues to grow. According to the New York Fed, while total household debt continued its decline in the second quarter of 2013, student loan debt tacked on another $8 billion.

This should come as no surprise as college costs, which are the ultimate driver of loan balances, have continued their meteoric rise.According to Bloomberg, the cost of obtaining a college degree increased by 1,120% over the past 35 years. To put that in perspective, over the same time period the cost of health care rose 601% and the cost of food rose 244%. What are the factors driving this increases?

  • Spending:  Many point to frivolous spending by schools on administrators, luxurious dorms, campus building projects, and other amenities.
  • Lack Of Funding:  As The New York Times pointed out,public colleges and universities, which enroll three out of every four American college students, have been hit hard by funding cuts as states struggle to keep their economic house in order. 
  • Profit Motivation:  The proliferation of expensive for-profit universities over the past 15 years fueled loan demand and, unfortunately, resulted in extremely high default rates.  
  • Uncle Sam:  Of the nearly $1 trillion in outstanding student loan balances, nearly 86% are backed by the federal government. Designed to provide access to education for all consumers — a noble goal — these loans carry no traditional underwriting criteria. Some argue this free-flow of cheap money has led to “massive overconsumption of higher education,” resulting in poor completion rates and exorbitant college prices. 

A Tipping Point?

There are many complex factors at play in the rise of college costs, but several recent items indicate a tipping point might be at hand. In a new report from Standard & Poor’s Rating Service, S&P said college costs have risen so much, “many of their customers can’t afford tuition without significant financial aid.” Schools that are unable to manage costs might be forced to take drastic measures, including staff layoffs, potential mergers, or even closures.

At the same time, recent research indicates students and families are placing a newfound emphasis on cost when deciding on a school and field of study. According to financial aid expert Mark Kantrowitz, the economic downturn, spiraling costs, and excessive student debt burden are forcing families to address affordability at the beginning of the college search process, a much different discussion than in years past.

Declining enrollment numbers should also give colleges pause. With a recovering economy and fewer college-age kids, it’s likely the small dip in college enrollment that has occurred over the past year will continue. Add in the spotlight on affordability, including President Obama touring the country presenting proposals for reducing the cost of higher education, and it’s very clear that colleges are under pressure like never before to rein in costs and rethink their business model.

Thoughts For The Future

Although no one has a crystal ball, it’s clear there are some interesting factors at play in higher education that will affect all stakeholders.

The Bipartisan Student Loan Certainty Act of 2013 means the debate over how federal student loan rates are determined can end. Hopefully, it also means the debate can shift to bigger issues, such as controlling college costs and creating a vibrant labor market for young adults.

These are monumental challenges that will take significant time and energy, so what can young adults and families do today? The simple answer is they must handle educational choices like any other large investment, such as buying a home. When purchasing a house, consumers ask themselves a litany of important questions: How much can I afford? What neighborhood best fits my needs — commute time, school district, public resources, property taxes, etc.? Does the location drive appreciation and resale value?

These questions can be easily converted to higher education: How much can I afford? What college best fits my needs — area of discipline, faculty-to-student ratio, student services, and graduation rates? Will the debt I incur by attending this college fit with expected income?

Filtering out emotion (as much as possible) and reviewing the school objectively against defined elements will help students and parents make smarter decisions.

If students or parents need private loans to fill funding gaps after exhausting lower-cost sources, they need to shop for the best deal and work with a trusted lender — just as if they were shopping for a mortgage. Both student and parent must verify the amount truly needed, understand the terms and repayment options, and be cognizant of who is the borrower — student, parent, or both? Private student lenders must fill the role of responsible counselor and trusted advisor. Financial literacy and education efforts are integral in helping would-be borrowers understand the impact of their decisions on their long-term fiscal health.

In the future, we all can hope college costs will decrease and become more affordable. But for now, as kids head back to school across the nation, it’s imperative that college-bound families ask themselves a question we all remember well … “Did you do your homework?”



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