Who Gets the 3.4 Percent Student Loan Interest Rate?

In his State of the Union address, President Obama called on Congress to postpone for one year the scheduled increase in student loan interest rates for loans issued for the upcoming school year. Without congressional action, interest rates on Subsidized Stafford loans for undergraduates will increase from 3.4 percent to 6.8 percent for newly issued loans. The president’s fiscal year 2013 budget, released last week, reiterated the proposal to postpone the rate increase.

The rate increase is the product of a 2006 Democratic campaign promise to cut student loan interest rates in half. Due to the cost of the original proposal, however, Congress limited the temporary 3.4 percent interest rate to a subset of student loans. The low 3.4 percent rate – compared to the 6.8 percent rate charged on Unsubsidized Stafford Loans for undergraduates, the most widely available federal student loans to all students regardless of income – is available only to undergraduate borrowers who qualify for Subsidized Stafford loans. To learn more about the history of the interest rates and the student loan program, check out this recently released Federal Education Budget Project issue brief.

As the debate over extending the current interest rate policy picks up, it’s worth examining which students actually qualify for the lower interest rate. This is especially important given that ultimately Congress granted the lower rate to only some borrowers to reduce the costs of the policy, instead of making it available to all borrowers as originally intended. Presumably, Congress limited the rate cut to undergraduate Subsidized Stafford recipients because they must meet a means test and are therefore the most deserving of additional benefits.

Yet data from a national survey – the National Postsecondary Student Aid Study (NPSAS:08) – cited in a Congressional Research Service memo and the president’s fiscal year 2013 budget reveals that “students across many income levels may be eligible for Stafford Loans depending on a number of financial considerations.” In fact, a review of these data shows that about a quarter of all Subsidized Stafford loans made to dependent undergraduate students are provided to families with gross incomes of $80,000 and above. About 13 percent of the loans are made to dependent borrowers from families with incomes of $100,000 and higher. These figures are in stark contrast to family income levels of students who receive Pell Grants – those grants are overwhelming awarded to the lowest income families.

While the needs-based formula that sets eligibility for Subsidized Stafford loans takes total family income into account, it also adjusts for cost of attendance. This means that middle and upper income borrowers can also qualify for these loans if they attend institutions with sufficiently high costs. It’s clear from the data that this provision means that Subsidized Stafford loans aren’t targeted to just students from low income families. As a result, the lower 3.4 percent interest rates the president has urged Congress to extend benefit borrowers from all income levels. That means the onus is on those who advocate extending the existing two-tiered interest rate policy to explain why the government should subsidize some middle and high income students twice as much as others. Sure, this system may cost less than providing the 3.4 interest rate to all borrowers, but is it fair? Is it good policy?