Relief for Student Borrowers?

The House has voted to reduce interest rates on loans, but critics say that action on grants is needed, too

by Julie Gordon and Kerry Miller

On Jan. 17 the new House Democratic majority made good on its pledge to lower interest rates on student loans, successfully pushing through a plan to trim rates on need-based subsidized federal loans by 50% over a five-year period. The measure, approved 356-71, is called a step forward by students and groups seeking lower college costs. But lenders and industry analysts said the bill, which was opposed by the Bush Administration, could end up being not as good a deal for students as it appears.

"Basically, what [the Democrats] are doing is making political points," said Tom Joyce, a spokesman for Sallie Mae, the largest originator of federal student loans. "It sounds good to say let's cut the lenders, but it's going to be students and schools that will pay the price." Shares of SLM (SLM), Sallie Mae's parent company, dropped after the election but have since rebounded. Standard & Poor's (MHP) analyst Stuart Plesser said that if the plan goes through, "it will definitely hurt [Sallie Mae's] bottom line," by shaving off margin in what's already considered a narrow-margin business. Sallie Mae's Joyce puts it at less than half a penny for every dollar loaned, or less than 50 basis points.

More Needed?

The House bill would reduce the interest rate on subsidized student loans from 6.8% to 3.4% over five years. Democrats said the measure will lead to lower rates for 5.5 million students and their families. The cost of the reductions—about $6 billion, according to the Congressional Budget Office—would be offset by changes in payments to lenders, fees paid by lenders, and a reduction in the share of default collections retained by guaranty agencies. The bill does not address loans taken out by parents of students or change provisions of the Pell Grant program, which goes to the neediest students. The Bush Administration says its favors grants to low-income students rather than interest rate cuts.

Some student advocates want Congress to go further in cutting college costs. Josh Weiss, student senate president at the University of Florida, said before the vote that the bill was a "step in the right direction," but he lamented the failure to increase Pell Grant funding, an issue that resonates strongly with lower-income students. Unlike loans, Pell Grants do not need to be paid back. For the 2006-2007 academic year, the maximum amount awarded is $4,050 (see BusinessWeek.com, 12/2/06, "Video View: Paying Off College Loans"). The bill also won't help current students, as it only applies to loans taken out after July 1, 2007.

Proponents of the bill said that when fully phased-in, borrowers would save $4,000 over the life of a $20,000 loan with a 10-year repayment period. However, critics say that students may not see that much in savings. Past cuts to the student loan program—including $12 billion last year, part of the Republican-led Deficit Reduction Act—have helped to drive some smaller players out of the student-lending market, a trend that will likely continue.

With less competition in the marketplace, lenders like Sallie Mae could start passing along the higher origination fees to students, or cutting back on services like default prevention programs. It could also threaten lending to smaller schools with higher default rates. "When you start adding it together, there's not as much savings to the student as Congress thinks there is," Plesser says.