Understanding the Full Benefits of Subsidized Stafford Loans

In the Budget Control Act of 2011 (aka the debt ceiling agreement) Congress provided the latest round of supplemental funding for the Pell Grant program. The law included $10 billion for fiscal year 2012 for the program and another $7 billion for fiscal year 2013. The law offset the cost of that one-time supplemental  funding by eliminating a type of federal student loan available to graduate and professional students — Subsidized Stafford loans.  These loans will no longer be issued to borrowers as of July 1, 2012. While this is old news to some, it’s come to our attention that Ed Money Watch posts and Federal Education Budget Project issue briefs do not fully explain an important nuance in what this policy change means for graduate students. Let’s set the record straight.

Since the early 1990s, federal student loans have been available to borrowers regardless of family income. This includes undergraduate, graduate, and professional students. In earlier years, only middle and lower income families qualified for federal student loans, and the federal government did not charge interest on these loans while borrowers were enrolled in school. When Congress opened up the loan program in the early 1990s to effectively all students regardless of income, lawmakers maintained the in-school interest-free benefit for lower to middle income borrowers but did not offer this benefit to higher income borrowers.  Interest on loans issued to higher income borrowers accrues (but does not compound) while the borrower is in school. The loans with the interest benefit are called Subsidized Stafford loans and those without are Unsubsidized Stafford loans.

When Congress eliminated Subsidized Stafford loans for graduate students last year, most reports of this policy change (including ours at Ed Money Watch) explained that graduate students will lose the “in-school” interest benefit on loans issued on July 1, 2012 and later. But borrowers of Subsidized Stafford loans received additional benefits beyond the in-school subsidy, and few reports have mentioned that these benefits have also been eliminated – borrowers qualified for an interest-free benefit during the six months after leaving school (the so-called grace period interest benefit) and under any deferment period, including the three-year deferment periods for unemployment or economic hardship.

What is more, Subsidized Stafford loans provide an important benefit under the Income Based Repayment plan that Unsubsidized Stafford loans do not.  A borrower with Subsidized Stafford loans who does not pay enough each month to cover the interest on his loans (“negative amortization”) has this unpaid interest forgiven. Subsidized Stafford loan borrowers are eligible for this benefit for up to three years of repayment.  The federal government does not forgive this unpaid interest for borrowers with Unsubsidized Stafford loans, meaning their loan balances can grow while using Income Based Repayment.  (It’s interesting that the Obama Administration has fought to make the Income Based Repayment plan more generous for borrowers but simultaneously supported eliminating the Subsidized Stafford loans for graduate students, which makes Income Based Repayment far less generous for these borrowers.)

In short, eliminating Subsidized Stafford loans for graduate students means more than the loss of the in-school interest-free benefit. It includes the loss of a whole host of interest-free benefits for graduate students that would have received subsidized loans. These benefits helped lower costs for borrowers not just while they were in school, but during periods when they needed to delay (deferment) or reduce (income based repayment) repaying their loans.  For some students, those out-of-school interest benefits may have been worth more than the in-school portion, and they should be included in any analysis of the effects the elimination of Subsidized Stafford loans will have on graduate students. Moreover, policymakers and education advocates should keep this more complete explanation of the interest benefit in mind as they debate any proposal to end the still-available benefit for undergraduate students.