As featured in The Wall Street Journal, Money Magazine, and more!
     

Banks Borrow Money at Low Rates, Why Can’t Students?

This article was written by in Education. 20 comments.


Senator Elizabeth Warren, the architect of the Consumer Financial Protection Bureau, introduced a bill in Congress to give student borrowers a break. The premise is that students, whose education is important to the economic growth of the United States, should receive some of the same advantages as banks, who receive preferential treatment in the form of low-interest loans from the Federal Reserve.

Since the midst of the recession, the Federal Reserve has kept its overnight lending rate low, below 1 percent, so banks could kick-start the economy by being able to afford to borrow. Overall, this strategy hasn’t worked. The financial industry instead used low-cost loans to increase their assets in their financial reports, an important move to show institutions were well capitalized, and to continue to pay executive bonuses despite upsetting short-term performance.

Money is fungible — you can’t track each dollar of business revenue and each dollar of loan and determine which dollar was used for which expense, but you should be able to expect banks to cut back on excesses during periods when the industry is being carried on the backs of taxpayers. After all, when taxpayers pay for public teacher’s salaries, newspapers publish salary tables and citizens are critical of waste in the system; you should expect the same scrutiny when taxpayers are footing the bill, at least temporarily, for financial industry CEO bonuses.

A well-educated populace is good for the economy and for this country’s competitiveness on a global stage, so it makes sense for those who have pursued a college degree to receive some benefits of economic stimulus. Students are leaving college is a low-employment environment. Half of the jobs added over the past few years have been low-paying jobs, and as a result, more people — not just recent graduates — are underemployed.

The interest rates for federally subsidized student loans is set to double to 6.8 percent this July. Every year, Congress goes through the same theatrics, and more often than not decides to lower this rate. Students who take out student loans today receive a favored rate of 3.4 percent. That’s a better deal, certainly, but not as good of a deal that banks receive, somewhere near 0.75 percent.

Elizabeth Warren sees this as an injustice. She says: “… [O]ur students are just as important to the economic recovery as our banks, and the debt they carry poses a serious risk to that recovery.” This isn’t wrong. Students saddled with high repayment obligations after college have less money to contribute to the economy right away. They’ll wait before getting married, before having children, and before moving into their own houses. Even income-based repayment plans, where your monthly student loan bill is reduced, don’t help in the long run.

Students bear responsibility for borrowing only what they can afford, but that depends on them having effective guidance. Student loan guidance before borrowing is completely ineffective.

Furthermore, society continues to push the idea that education is worthwhile regardless of the cost. I’m a strong believer in the importance of life-long education, which for me includes degree programs, but not in borrowing at any cost. Everyone should be able to afford a college education, but perhaps we shouldn’t subsidizing as many students who choose to attend expensive private schools rather than the more reasonable state colleges and universities.

To receive those interest rates of 0.75 percent, banks have to put up collateral. Student loans are somewhat riskier than loans to banks. First, these are overnight loans for the banks — very short term, very low risk. Student loans live for a decade or more, and students have a stronger chance of being unable to make the payments. That leads to higher interest rates — those who dutifully pay back their loans in full help subsidize those who have problems.

Yet, a student loan is the only type of borrowing that cannot be discharged in a bankruptcy, and that helps reduce the risk to lenders (while making life difficult for some borrowers).

Warren is looking for a reduction of the student loan rate to 0.75 percent for just one year, at which time Congress would need to vote again.

My gut reaction is that Warren is right — it’s not “fair” that students have to pay more to borrow money than banks. There is a solid economic for the difference in rates, though. There’s no question that a well-educated populace is better for society, so what could the government do to help students without increasing risk to lenders?

  • Perhaps there needs to be a more discriminating table of interest rates for student loans rather than one rate for everyone. Each student’s own situation, including proposed course of study and society’s need for jobs in a certain industry, should be evaluated to determine interest rates on an individual basis.
  • Perhaps there should be more student loan repayment assistance for those who graduate and take a job in a sector that is in high demand.
  • Another option is for there to be more policies that encourage private organizations to offer education grants and scholarships.

Policies for students ignore the bigger problem of the skyrocketing cost of education. You can’t control costs when society is continually making it easier for more people to afford college. Educational institutions need to control enrollment, and they can do that by raising the sticker price. The more free and low-cost credit is available to students, the more colleges can raise tuition without damaging their enrollment.

In the end, the problem of education affordability is multi-faceted, and while I would vote for a bill such as this myself, I don’t expect Congress to pass it. I expect they will continue to do what they usually do: lower the interest rate from 6.8 percent, but without going as low as 0.75 percent.

Photo: Flickr

Updated July 5, 2013 and originally published May 14, 2013. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

Email Email Print Print
avatar
Points: ♦127,475
Rank: Platinum
About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 20 comments… read them below or add one }

avatar Jenny @ Frugal Guru Guide

“Policies for students ignore the bigger problem of the skyrocketing cost of education. You can’t control costs when society is continually making it easier for more people to afford college.”

Exactly! The whole reason that educational costs skyrocketed out of control is that anyone can get a loan for the amount of their tuition without even having to prove that they will ever be able to pay it back. There is NO connection between the value of a degree and the amount you’re allowed to borrow. That’s crazy. Making it EASIER to borrow will just make the situation worse.

Reply to this comment

avatar Apex

Jenny is exactly right.

I am confused by the statement that Jenny quoted and your statement that you favor lowering the rate. If you make the rate really low that makes the payment really low which makes the loans much easier to carry. If you make a loan much easier to carry you are likely to get more of them and for larger amounts. This allows universities to raise tuition to suck up the extra money. That line of reasoning follows directly from statements you made in your second to last paragraph.

Given that you acknowledge the problem of making it easier to afford college driving costs up, and that skyrocketing prices is a problem, why do you then advocate for a policy that will make it even easier to afford college? By your own logic that will simply drive costs even higher.

I am confused by the apparent contradiction in your own statements.

Reply to this comment

avatar Luke Landes ♦127,475 (Platinum)

Life is full of contradictions, isn’t it? It’s a matter of weighing the outcomes, and managing short-term fixes while looking for ways to solve problems on a larger scale. I would like to see continued low interest rates — Congress will surely extend low rates for student loans in some form, though definitely not at the 0.75% rate — while addressing the larger societal problems with the affordability of college that politicians are generally happy to ignore because they’re focused on nothing beyond the next election.

Reply to this comment

avatar Apex

ok, fair enough.

But given your statement that making college easier to afford drives up costs (a catch-22 in itself). What do you want to see done?

Based on your statement anything that makes it easier to afford will make it more expensive which will just counter act the part that made it easier. That is what that statement means isn’t it?

This is not a challenge. I am interested in what all sides are proposing on this issue. What do you think would help or want to see lawmakers do that could lower costs or keep them from going higher?

Reply to this comment

avatar Luke Landes ♦127,475 (Platinum)

Well, I’d probably start looking at some of higher education’s biggest expenses. I would have to look into this more, but I would imagine that athletic programs in some schools top the list, and I would also guess that athletic programs pay for themselves in some cases. I think scientific research facilities should be separated from education in terms of operation, and I’d replace that with associations or affiliations with private sector research. Research is still core to many fields, but there might be some other structure that works better. I’d look into different regulations for endowments… for example, dealing with how the “expensive” elite schools end up costing less to attend than state schools. Maybe there should be an incentive for contributing to educational institutions beyond the charitable contribution tax deduction.

There is a world of factors to explore, and I don’t have the operating knowledge of the academic industry to have those kinds of answers.

avatar Jenny @ Frugal Guru Guide

Reply to Luke–actually, at most universities, the football team and a couple of other sports funds the entire athletic department. They are self-sustaining. And new football stadiums, etc., usually come from specific donations from alumni, not from the endowment.

Administrative bloat is driving up tertiary education enormously. A good hunk of that is self-inflicted. Others are required by various laws making public universities conform to this standard or that–this costs many millions a year and is constantly increasing. (Private universities don’t have to follow those sorts of laws, BTW.) Other problems include the reliance on tenured professors to teach an ever-increasing number of students. There isn’t enough research grants to go around to pay for the professors that have to be hired–it used to be that research basically subsidized teaching, but now it can’t because way too many people go to college. More lecturer positions need to be created–that’s teaching-only positions, where the instructor has a PhD but has a higher class burden and does not participate in research. Also, appropriate use of technology–for example, there is NO need for live sage-on-a-stage lectures with today’s technology–to increase lecture quality, decrease continuing teaching burdens, and monitor student comprehension better really needs to be delved into.

My mother is an educational STEM grant writer and researcher. :)

avatar Jenny @ Frugal Guru Guide

I wouldn’t oppose lowering interest rates for existing student loans, personally, because, yeah, people get themselves into messes making dumb degree decisions, BUT every other self-made financial nightmare has some way out.

Conversely, I believe that in the future, every tertiary institution should have to provide proof of average earnings for grads in each major to prove the ROI of that major, which should determine the loan threshold. If loans were based on REAL expected earnings, there would be no student debt crisis. Sure, you wouldn’t be able to go into 100% debt to get that philosophy major (and I LOVED my philosophy courses, so I’m not saying philosophy is bosh–it isn’t), but you SHOULDN’T go into debt for something that has no monetary value. It just makes no sense.

Reply to this comment

avatar jim

Student loan availability is not “the whole reason” college costs increase.

Reduced tax subsidies by states is a huge factor in college costs. I might say its the primary factor.

Of course its a market and the costs are balanced by what people are willing to pay.

Consider this : Tuition at my local state university is around $8,000 a year. Tuition at the local private catholic high school is about $10,000 a year. If student loan availability is the ‘whole reason’ that tuition is skyrocketing then why is the state school cheaper than the catholic high school?

I understand the logic that student loan availability can result in higher tuition. But at the same time I see no real proof that this is the cause and effect going on. Do we blame car loan availability for the high cost of cars? Who can’t get a car loan?

Reply to this comment

avatar Jenny @ Frugal Guru Guide

The subsidies decreased because no one was being denied education with student loan policies being so loose. States are VERY interested in keeping education affordable. Right now, everyone can get a loan, so everyone can magically “afford” college, so it doesn’t matter what it actually costs the student.

There would be higher subsidies and also much stronger community-to-four-year paths if it weren’t for the out-of-control levels of student loans. Also, trade schools wouldn’t have been so systematically destroyed–and students are WAY better off graduating from a trade school than trying and failing at a 4 year college, and often they are better off than GRADUATING from a 4-year college in certain majors.

Reply to this comment

avatar Grayson

I am not sure how I feel about this because does this help the ones that already have student loan debt? What about helping those people out because they are the ones that could stimulate the economy quicker as they are already out and most likely on a career path.

Reply to this comment

avatar jim

My understanding is that the 0.75% lending rates that banks get are short term loans and I assume theres collateral related to those loans and I assume banks have relatively low default rates on those loans. Students borrow for long terms generally 10 years and have no collateral at all, no credit history and default in fairly high rates, plus their eligible for writeoffs and loan forgiveness.

While it makes good populist political theater to whine about how the banks get such a great deal and students are supposedly abused with 6.8% interest rates, I think it makes quite good sense to lend to banks at lower rates than students given the quite different situations.

Reply to this comment

avatar Steve

It’s true that the rate for overnight rates should be lower than the rate for long term loans like student loans. There are risks outside of default, such as interest rate risk (if/when rates go up) to long term loans.

On the other hand, since student loans (at least the ones being discussed here) are guaranteed by the government, the default risk is practically zero.

So in the end, Luke is right; the rate should be higher than 0.75% but probably lower than 6.8%.

Reply to this comment

avatar jim

Borrowing for the subsidized federal loans is directly from the federal government. So its not ‘backed’ by the government and there isn’t a bank acting as middleman. If a student defaults the government loses interest. This isn’t about a bank being made whole by the government. In the past banks originated the subsidized loans and they were backed by the government but not any longer. Now Uncle Sam is the actual lender.

Reply to this comment

avatar jim

“a student loan is the only type of borrowing that cannot be discharged in a bankruptcy,”

Tax debts are also generally not discharged in bankruptcy.

Reply to this comment

avatar krantcents

I agree with you that a lower rate of interest would be very beneficial to society. Why don’t banks lend money a a lower interest rate in general with the rate they can borrow at near zero. Although student loans are guaranteed by the government, they are still serviced and initiated by private banks. Profit trumps society!

Reply to this comment

avatar John S @ Frugal Rules

I do agree that a lower rate would generally make it easier and would think that it would be beneficial to apply it to those who currently have student loan debt as well. That said, I think tis is only one aspect of the larger problem of student loan debt. There are many other pieces and I hesitate to think that this alone will make it easier for students. I was reading an article the other day on Yahoo Finance talking about the skyrocketing salaries for many university presidents and linking it to the rise in tuition. This is yet another problem and the whole is just like an onion…having many layers.

Reply to this comment

avatar Michael @ The Student Loan Sherpa

I find the debate over federal student loan interest rates to be very frustrating. The federal interest rate is just one tiny part of a much bigger problem. Tuition costs have skyrocketed, for profit universities continue to take advantage of students, private lenders have far worse terms than federal loans (and for many, these loans are necessary), students don’t understand the consequences of student loans, and schools and lenders are making billions so the lobbying money is not being spent on helping people in over their heads on student loan debt.

Something comprehensive needs to be done. If I was a Sallie Mae executive or a board member of a for profit school I want people to continue arguing 6.8% vs 3.4% vs .75% Either way, I continue to get rich.

Reply to this comment

avatar Andrew Ghezzi @ Nestwise

Great article and really timely content given that this issue has taken center stage recently.

I see the colleges in my area using reasons for higher costs such as claiming that it costs more to keep their high tech equipment up to date and one better…..given how many more students are applying for popular programs ( due to more student financing being made available) they have to expand class space and faculty in high demand fields in order to accommodate.

And yet in some universities their endowments are ballooning. Doesn’t make sense.

No matter how this is presented by the schools, one common theme I hear more and more from clients and family is that “the plan” is to seed community colleges and local universities and then transfer say after two years into the college of choice. You still get the diploma you want and you end up paying 30% less for the degree.

Reply to this comment

avatar Kirk7102

Banks borrow and lend money to the benefit and growth of our economy. Lending money to students for college so they can be indoctrinated is a waste of time and money!

Reply to this comment

avatar qixx ♦1,890 (Half-Dollar)

I’m not sure how or why but my student loan is currently at 0.39% and recently moved to that from 0.54%. It stated at 6.somthing%. Moved to 5.somthing% then to 2.45%. i think the drop to 2.4 then .054 then to 0.39 might be connected to my Income Based Repayment plan. It could also be just good luck on my part. Either way it is less than the 0.75% proposed. That seems to suggest to me that the 0.75% is plenty fees-able.

Reply to this comment

Leave a Comment

Connect with Facebook

Note: Use your name or a unique handle, not the name of a website or business. No deep links or business URLs are allowed. Spam, including promotional linking to a company website, will be deleted. By submitting your comment you are agreeing to these terms and conditions.

Notify me of followup comments via e-mail. You can also subscribe without commenting.

Previous post:

Next post: