The Democratic presidential contenders agree on at least one thing about student loans: Interest rates are too damn high.
Hillary Clinton told the New York Daily News this month college students are often paying “above market level” interest rates on federal loans.
“It is outrageous that young people are being asked to pay interest rates that are so much higher than interest rates to buy a house, a car, or just about anything else,” she wrote in the Huffington Post last month.
Her rival Sen. Bernie Sanders accuses Washington of “profiteering on the backs of college students.”
“It makes no sense that you can get an auto loan today with an interest rate of 2.5%, but millions of college graduates are forced to pay interest rates of 5-7% or more for decades,”his campaign website says.
The presidential candidates paint a picture of students being unfairly burdened with high rates. But it’s not so cut and dried. Here are answers to common questions about student loans.
Are interest rates on federal student loans higher than what private lenders charge?
No. And it’s a bad comparison.
The government charges undergraduates a fixed rate of 4.29% for loans taken out in the current academic year. It charges 5.84% and 6.84% for graduate students. (Loans taken out in subsequent years will carry different rates—which will still be fixed, not variable–based on whether the government’s own borrowing costs rose or fell.)
But here’s the key: the government imposes virtually no credit checks, and it doesn’t require co-signers. That means it’s making a lot of loans to risky borrowers who are unlikely to repay their debt. The government also offers all borrowers—no questions asked—the chance to slash their bills (through income-based repayment) and to eventually have some debt forgiven.
These are extremely generous terms that aren’t offered on the private market.
Private lenders generally only make loans to safe borrowers with high credit scores, and in many cases they require co-signers.
For those who do qualify, fixed rates are comparable to federal loans or higher. SLM’sSallie Mae, the biggest private student lender, advertises fixed rates from 5.74% to 11.85%. (It also offers variable rates of between 2.5% and 9.59%, but the federal government offers no such product.)
Without the federal program, most borrowers would pay higher rates on the private market or have no access to loans at all.
“Traditional students with thin credit histories would almost never be able to afford private loan options and banks would be highly reluctant to lend to them without the kinds of co-signer assurances we see today,” says Carlo Salerno, an education economist who has consulted for the private student-lending industry.
By the way, roughly 90% of new student loans come from the federal government.
Are Student-Loan Interest Rates Higher Than Car-Loan and Mortgage Rates?
Yes, and for good reason. Student loans aren’t backed by an asset.
Banks can seize a car or foreclose on a home when borrowers fail to repay. There’s no asset to seize with federal student loans. By not imposing credit checks and requiring no collateral, the government is taking a huge leap of faith that it will get its money back.
The Education Department does have the power to garnish wages, tax refunds and Social Security checks, but it has trouble reaching defaulted borrowers. And even when it does, the government often doesn’t recover the full amount.
Susan Dynarski, a nonresident senior fellow at the Brookings Institution, writes that this is the very reason private student lenders have traditionally only been a niche market.
“It is very difficult for private parties to place a lien on (or even confirm) individual earnings,” she writes. “This private market failure is one reason why government plays an important role in lending for education. Governments, through the income tax system, have the unique ability to both measure and collect income.”
Given just how easy it is to obtain a federal student loan, it’s little surprise that college students are notoriously bad about repaying debt. As of Jan. 1, more than 40% of the roughly 22 million Americans who owed federal student loans and were out of school were behind on payments.
Is the Government Profiting From Student Loans?
It depends on the math.
The government uses an accounting method that differs from that of private lenders, and under that accounting method, it books a profit. But using the private sector’s method, student loans lose money.
Even under the government’s accounting method, it loses money on undergraduate student loans. It does, however, book a profit by lending to graduate students and parents, who pay higher interest rates than undergraduates. Essentially, the government is taxing graduate students to subsidize undergraduate students.