With the start of classes just weeks away, Maryland financial aid directors sighed with relief that Congress has finally reached an agreement on student loan interest rates that will lower costs for borrowers this academic year.
"We have been getting calls from students," said Zhanna Goltser, director of financial aid at Notre Dame of Maryland University in Baltimore. "It's great that it will save money for students who are borrowing now."
"Now" is the key word. Under a new formula created by lawmakers, the rate on certain federal loans could go up significantly in a few years.
A gridlocked Congress failed to meet a July 1 deadline on expiring rates, resulting in the interest on new subsidized Stafford loans doubling to 6.8 percent. Subsidized means that Uncle Sam pays the interest on the loan while the borrower is in college.
But under bipartisan legislation that passed its final congressional hurdle last week, the rate for all Stafford loans as well as PLUS loans used by parents and graduate students will be tied to the market. Given today's low interest rates, students and parents will enjoy reduced interest rates for the time being.
"It's an interest rate increase masqueraded as a decrease," warned Mark Kantrowitz, publisher of Edvisors.com, a network of websites on college admissions and financial aid.
As the economy continues to improve and interest rates rise, families in a few years could be paying substantially more to borrow from the government, he said.
Under the legislation, the interest rate on Stafford and PLUS loans will be a combination of the yield on a 10-year Treasury note and a flat rate, depending on the type of loan. Congress also added caps to limit how high rates can go.
The rate on Stafford loans for undergraduates will be the yield on the 10-year Treasury plus 2.05 percent, not to exceed 8.25 percent. Interest on Stafford loans for graduate students will be the Treasury yield plus 3.6 percent, but no more than 9.5 percent. The PLUS loan rate will be the Treasury yield plus 4.6 percent, with a cap of 10.5 percent.
Each year, the rate for new loans will go up and down with the Treasury yield. But once a loan is taken out, the interest rate is fixed for the entire term.
The president is expected to sign the bill. The legislation is retroactive, so the formula will be in effect for loans made since July. The new rates for this year will be 3.86 percent for undergraduate Stafford loans, 5.41 percent for graduate Stafford loans and 6.41 percent for PLUS loans, aid officials said.
That is significantly less than borrowers would be paying if a deal hadn't been brokered. Without the legislation, the rate would have been 6.8 percent on all Stafford loans and 7.9 percent for PLUS loans.
"Families will be happier with this tied to the market just like any other [loan] they would have taken out," said Dana Kennedy, director of financial aid at St. John's College in Annapolis. And this way, students and parents will know each year what the interest rate will be, rather than waiting for an act of Congress, she added.
Some parents recently advised their children not to sign loan papers until Congress decided on a rate, Kennedy added. They feared that borrowers could be locked into a higher rate by signing early, though lawmakers were expected to make the rates retroactive to July 1.
"We're pleased that students are going to see some relief this current school year," said Tom McDermott, director of student financial services at the Johns Hopkins University in Baltimore.
Still, the caps are on the "high side," said McDermott, who hopes Congress will revisit the issue.
McDermott said he's concerned that if federal loan rates climb significantly, students and families might switch to private loans that do not offer the same protections and benefits as the government. And some aid experts predict that higher rates are ahead.
"We don't see it as a cause for celebration," said Lauren Asher, president of The Institute for College Access & Success in California. "The cost to families over the 10 years would be more than if Congress did nothing."
The legislation is projected to generate $715 million in added revenue for the government over the next decade as rates rise, Asher said. And that's on top of the $184 billion profit the loan program was already expected to see over that time, she said.
Asher predicts that parents will be paying more than the current 7.9 percent on PLUS loans by 2016, and undergraduates will borrow at a rate higher than today's 6.8 percent on Stafford loans by 2017.
"By 2020, we are going to hit those caps" set in the legislation, Kantrowitz said.
But some aid directors say they are focused more on what is fair to students given what is known today, not what might happen.
"Nobody has an accurate crystal ball," said Sarah Bauder, assistant vice president for financial aid at the University of Maryland, College Park.
The compromise reached in Congress is "fair and equitable," she said.
Students and parents will be protected against high interest in the future by the rate caps, Bauder added. And if rates skyrocket to 17 percent as they did in the early 1980s, that 8.25 percent cap will seem like a great deal, she said.
Though much of the attention in recent weeks has been on interest rates, Kantrowitz said students would be better off looking for ways to minimize their college debt.
As a rule of thumb, students should not borrow more than their first year's annual salary after graduation, Kantrowitz said.
Families need to save for college long before a student heads to campus and take advantage of tuition tax credits, he said. They can also pay tuition on an interest-free installment plan over the course of the school year to reduce borrowing.
His advice to students is to search for scholarships and learn to be frugal.
"Live like a student while you are in school so you don't have to live like a student after you graduate," he said.
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