The Case for Lowering Student Loan Interest Rates

June 14, 2012 at 10:17 AM Leave a comment

The frenzied debate on renewal of interest subsidies on student loans has missed a key piece of the puzzle: interest rates on student loans are too high. Banks are making more profit than they could make elsewhere in the market on job-creating corporate and small business lending… And new lenders are jumping into the market without government guarantees or collections support.

Interest rates on student loans are excessive. In order to help students finance their higher educations, the US government should pursue a combined strategy of lowering overall interest rates for college student loans and subsidizing interest costs for some students based on need.

The high interest rates have triggered over-participation in the college lending arena. Availability of funding has created slack for colleges, which have allowed costs to rise excessively. As a result, students have assumed an unprecedented debt burden during the worst economic conditions in almost a century. Something has to give, but the government cannot afford to carry the total weight of the problem.

The DOE has approached the colleges on the issue of cost containment, and students in financial distress are being assisted with modifications to their loan repayment plans. In addition, the US has picked up half the interest rate costs to students for some of these loans. However, there is a deadlock in Congress on the issue of renewal of interest rate subsidies to students on loans in the future. While the debate has focused on how to pay for these subsidies – via spending cuts or deficit spending – the cost of the subsidies themselves could be reduced without greater cost to students. The solution? Cut the overall interest rates on student loans.

There is evidence that returns on student loans are higher than the free market would allow. The first clue is that banks have loaned over $1 trillion to students…more than they have loaned to the entire population of adults via credit cards, the former linchpins of usury. This has occurred in an era of supply-side economics, when government policies gave freedoms to businesses and financiers to support industrial development and job creation. The opportunity cost of job creation, instead of student lending, must have been too high; the money went to student loans…not job creation.

In addition, many student loans taken before 2009 carried a government guarantee and government agencies still assist in the collections effort. Despite elimination of the guarantees, banks remained content with the business, especially as interest rates have continued to drop in all other markets. In fact, there has been new competitive entry into the student loan arena of late from financial institutions that are willing to lend to student WITHOUT government guarantees or agencies assisting with collections. This is a sure sign of excessive profit-taking.

The US government should lower the interest rate it allows banks on college student loans.

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Entry filed under: Higher Ed Issues, Special Rants. Tags: , , .

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