Policy Analysis | June 2012

The Stafford Loan Crisis in Perspective

Jonathan Watts Hull

Last-minute Congressional action seems poised to stop interest rates on subsidized federal Stafford loans from doubling from 3.4 percent to 6.8 percent on July 1. The legislation, passed along with a the extension of the highway bill that faced the same deadline, pays for the $6 billion cost of the plan by shortening the eligibility time for the subsidy (to six years for programs intended to be finished in four years, and three years for those intended to be finished in two), as well as through new fees on federally-insured pensions and changes in how companies calculate money set aside for pension programs, essentially cutting their deductions.

Stafford loans are low-interest loans for undergraduate and graduate students at accredited post-secondary institutions. The loans are available directly through the U.S. Department of Education and are among the lowest cost means for paying for college. The Stafford program includes both subsidized and unsubsidized loans, with students demonstrating financial need eligible for reduced interest rates and delays in the charging of interest.

The Budget Control Act of 2011, approved by Congress and signed into law in August, 2011, eliminated the subsidized loans for Stafford Loans on July 1 as part of the sweeping deal designed to resolve the debt-ceiling crisis. Extending the subsidies on Stafford Loans carries a price tag of $6 billion according to the Congressional Budget Office. Under current budgeting rules, continuing the subsidy would require either cuts of the same magnitude elsewhere in the budget or increased revenue. In April 2012, the House of Representatives passed a bill that would have extended the subsidy, funding the measure by cutting funds to a preventative healthcare program, a move rejected by the Senate and the Obama administration. Legislation to extend the subsidy for a year proposed in the Senate would have paid for it by changing a law that permits some wealthy taxpayers to classify their pay as dividends to avoid paying Social Security and Medicare taxes on it, a move that did not meet the required 60 votes needed to reach the floor. The stalemate in both chambers has placed the continuation of the Stafford loan subsidy in jeopardy.

A doubling of the interest rate for subsidized loans would have an impact on new loans taken out by the roughly 7.4 million students who are eligible for the program, with the higher interest rate resulting in about $1,000 in additional cost for each year (or less, FinAid.org pegs the average repayment increase at $761) . Most students using financial aid for college use a variety of tools to fund their education, including a mix of loans, institutional aid, federal grants, and other sources. The number of students receiving subsidized loans amounts to only one-third of all students enrolled in post-secondary education. An increase in costs of any kind for the low-income students can derail their path to higher education success. The monthly repayment cost of the difference in the interest rates has been projected to be less than $10 a month over the life of the loan, which somewhat ameliorates the impact of the end of the subsidy.

The focus on the situation with the potentially-expiring Stafford subsidy has, in some ways, moved attention away from more core issues affecting overall affordability of higher education: rising institutional costs and declining grant aid to low-income students. It often has been pointed out that college costs are rising faster than inflation, faster than even healthcare costs. U.S. Education Secretary Arne Duncan noted in a press conference in June that "as costs keep on rising, especially at a time when family incomes are hurting, college will become increasingly unaffordable, not just in disadvantaged communities but for the middle class."

Costs are rising at least in part because states have cut their support for higher education, even as institutions are seeking to make larger investments to remain competitive. In 2011, 40 states reduced their support for higher education, reductions that were almost universally translated into higher tuition and fee costs for students. These two trends have combined to shift the share of public college costs, with tuition rising as a share of total revenues, from 30 percent in 2001 to 43 percent a decade later. Over the same period, state appropriations as a share of college revenues has declined from 56 percent to 42 percent. Colleges also are engaged in an "arms race" over prestige and status, which results in increased investments in infrastructure for student life, academic programs, and institutional facilities. The shift in the percentage of funds a school receives from tuition (now at about 40 percent, up from roughly 30 percent a decade ago) has meant that schools

A second piece of the affordability puzzle is declining grant aid, particularly cuts to the Pell Grant program. Over the past two years, the Pell Grant program, which provides aid to low-income students, has been reduced $10 billion. Among the recent changes to the program was a reduction in family income for recipients eligible for grants without family contribution, from $32,000 in 2011 to $23,000 in 2012, which eliminated 12,000 students from eligibility for the program and reduced awards for more than 274,000 more. A further change reduced to 12 (from 18) the number of semesters a student was eligible for Pell Grants. Part of the funding that Congress is using to shore up the Stafford subsidy was being considered by the Obama administration for extending Pell Grants.

Alongside reductions in federal grant-in-aid has been a slowing of need-based aid, compared to the rise in college costs. Over the past five years, total need-based grant aid has risen 17 percent in constant dollars. Over the same time period, state appropriations per full-time student have declined 12.5 percent in constant dollars and published tuition and fees have increase by 28 percent. Institutional grant aid is an important part of many students' financial aid packages, with 20 percent of students receiving some institutional grants with an average amount of nearly $5,000. This aid is not targeted at low-income students, however, with institutional grant awards distributed evenly to students across family income ranges, with total award amounts actually increasing as family income rises. Moreover, institutional grant aid is unevenly available across institutions, placing those colleges and universities with limited endowments available for this purpose at a disadvantage.

The effort to step in and stop the increase in subsidized Stafford Loan interest rates will provide some relief to low-income students seeking post-secondary education, but only in a limited way. As the next school year comes into view, the need for the economy to have more workers with some post-secondary education is on a collision course with issues of affordability and access. The student loan debt bomb is more a symptom of the problem than the root issue. Higher education costs have grown exponentially over the past 30 years, incomes for most college graduates have stagnated, and the debt-funding model for accessing the historically most reliable pathway to the middle and professional class is becoming a hurdle to economic participation for Americans under 30.

Inevitably, as the United States economy makes the transition from one in which post-secondary credentials serve as a tool for advancement to one in which they are an essential key to entry, college access and affordability will need to be resolved. Fixing this complex problem involves rethinking college finance models, (an issue that is on the agenda at the SLC Annual Meeting this summer), controlling college costs, and aligning student aid with both public and individual needs. There also is work to be done in the arena of student loans, including requiring more accountability and risk assessment from private lenders and providing more information to students about the costs of their loans and the potential income they can expect from the certificate or degree they are pursuing.