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Why Rising Student Loan Rates Aren't the Real Problem

Posted
7/2/2013 9:50:00 AM
By: Motley Fool
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Yesterday, interest rates on new federally subsidized Stafford student loans doubled from 3.4% to 6.8%. The move brought an angry response from students and parents who could see their financing costs soar if the government doesn't take action to reverse the move.

Taking positions that have students have to pay more for their college educations isn't popular. But all the attention on student loans distracts from the real root of the problem for students: the increasing disconnect between the value of an education and the price that colleges and universities charge for it.

More proposals than you can count
Lawmakers have no shortage of rate-reducing alternatives to consider. Both President Obama and House Republicans suggested tying interest rates to the prevailing yield on 10-year Treasury bonds, with differing margins added on for various types of loans. For instance, the House plan would set Stafford loan rates at 2.5 percentage points above the 10-year yield, with parental PLUS loans getting a 4.5-percentage-point add-on.

Other proposals have used a variety of other benchmarks. Sen. Elizabeth Warren suggested using the Federal Reserve discount rate of 0.75% as the prevailing rate, while two other Democratic senators suggested using the short-term three-month Treasury bill rate as a baseline for loan rates. Several lawmakers are working on possible extensions that would temporarily keep the old 3.4% rate for another year or two.

Getting rid of loans entirely
The government response to the college-cost crisis focuses on the wrong part of the problem. That's not particularly surprising, given that addressing interest rates on student loans simply repeats the government's own bipartisan fiscal mistakes that have irresponsibly ignored the need to avoid incurring excessive debt in the first place.

In response, students have to be smarter about making financially savvy choices about their education. There's plenty of evidence that there's room for improvement on that score:

On the other hand, students do seem to be making some moves that indicate greater fiscal responsibility for their own financial lives. Just last week, for-profit educational institution Apollo Group reported sharply lower enrollment, including a 25% drop in new students. ITT Educational saw more modest declines when it reported in April, but new student enrollment was still down 3.6%. A new investigation last month from the SEC over Corinthian Colleges marked just the latest in a string of regulatory crackdowns on for-profit educational institutions. More generally, increased government scrutiny as well as reports of higher student-loan default rates among many players in the for-profit industry compared to nonprofit educational institutions have led would-be students to question the value proposition for-profit educational companies offer.

Supply and demand
Of course, there are plenty of interested parties who want the student-loan business to continue to grow in some form. Student-loan specialist Sallie Mae as well as big banks that make student loans earn substantial profits from their loans, and federal guarantees greatly reduce the risk that lenders take on with some loans, making the absolute level of interest rates much less important for certain types of lending.

But the real question going forward is whether students will start making tough decisions about whether traditional nonprofit colleges and universities give them more long-term value than their tuition costs. As long as schools have more people applying for admission than they have spots to fill, it'll be tough for students to get the pricing power they need in order to drive their tuition costs down. Eventually, though, reining in tuition costs will be the prime determinant of the financial health of students after they graduate -- not the rates they pay on student loans.

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Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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