6 ways the debt deal could hurt college students

NEW YORK (AP) ? College is already expensive. Now the government’s 11th-hour agreement to raise the debt ceiling is set to push costs higher.

That’s particularly true for those pursuing advanced degrees, with the government eliminating subsidies to graduate and professional students as one way to cut back. The upside is that the savings will be used to help preserve the Pell grant program, which provides critical funding for low-income students.

But that’s not where the budget tightening ends. A bipartisan panel of lawmakers is set to identify at least another $1.2 trillion in deficit reductions by Thanksgiving, meaning college aid programs could face further cuts.

There’s also the lingering possibility that the country could lose its top-notch credit rating, which would push up interest rates on private student loans. A broader decline in the stock market could also eat away at college savings that are invested in the stock market.

Here’s a look at how the deal in Washington could impact six aspects of paying for college:



Starting next July, graduate and professional students will no longer be eligible for subsidized federal loans. These loans keep the cost of borrowing in check because the government doesn’t charge interest while students are in school. That can have a big impact on how much is owed upon graduation.

Graduate students can take out up to $107,500 in federal loans, of which $42,500 can be subsidized. They’ll still be able to borrow the same amount once the change goes into effect, but no subsidized loans will be available. The additional cost of an unsubsidized loan could push up total debt at graduation by an average of about 16 percent, according to Finaid.org, which tracks the financial aid industry.

There aren’t any indications so far that the government will do away with subsidized loans for undergraduates, especially since such a move would face widespread political opposition. About 7.5 million undergrads a year rely on subsidized federal loans, compared with 1.5 million graduate and professional students.


The $17 billion in savings from eliminating subsidies for graduate and professional students will be used to fund Pell grants. But the extra money only helps bridge a funding shortfall so the program won’t have to make any cuts in the immediate future.

The preservation of Pell grants is seen as critical because they provide undergraduate funding to the neediest students; the vast majority of the 10 million recipients have family incomes of $40,000 or less.

For now, students will still be able to get a maximum grant of $5,550 a year. But the odds aren’t looking good for the annual cap increases scheduled from 2013 to 2017, notes Terry Hartle, vice president of government affairs for the American Council on Education.

Even with the funding injection, the program faces an estimated operating shortfall of $1 billion for the 2012 school year. And that gap could widen if the economy deteriorates and more students apply for grants.

That in turn could force the government to consider tightening eligibility requirements or lowering the maximum grant amount, Hartle said.


The government’s debt deal also eliminates a discount given to borrowers who make their payments on time.

The amount of the discount varies depending on when the loan was issued. But for federal loans made after July 1 of last year, students get a discount of 0.5 percent of the loan amount for making the first 12 payments on time. On a $10,000 loan, that’s a one-time rebate of $50.

The incentive disappears for loans disbursed after July of next year. But the debt deal allows for the maintenance of another key discount. Borrowers who set up automatic debit payments get an interest rate reduction of 0.25 percent. Most federal loans come with a fixed 6.8 percent rate.


Federal loans are considered superior to private student loans because they come with a fixed interest rate that tends to be lower than the variable rates on private loans. But the debt ceiling ordeal has raised the question of whether the government will keep its rate at the current 6.8 percent.

Even though the government avoided a default, Moody’s rating agency on Tuesday gave the country’s credit rating a negative outlook. That means there’s a still a chance for a downgrade, which in turn would raise the government’s borrowing costs.

“At some future date, the government could decide to pass on the increased costs (to students),” notes Mark Kantrowitz, the financial aid expert who publishes Finaid.org.

Meanwhile, the rates on private loans would no doubt rise if the country’s credit rating took a hit. That’s because private loans typically have variable interest rates that move in tandem with a benchmark rate. In the event of a downgrade, Kantrowitz estimates that rates on existing private loans could rise by 0.25 to 1 percent or more on new private loans.


There’s also the possibility that tax breaks to offset college costs could be scaled back. A bipartisan panel of 12 lawmakers will have the option of making tax reforms part of its proposal to reduce the deficit.

The likelihood that the committee would scale back tax breaks for college costs seem small. But it’s worth noting that almost 10 million taxpayers deducted student loan interest in 2009, according to the Tax Institute at H&R Block. Taxpayers can also claim a credit of up to $2,500 for college costs under the American Opportunity Credit through next year. After that, they’ll be able to claim a credit of up to $1,800 for the first two years of college as the HOPE credit is reinstated.


Another concern is how the stock market will impact their 529 college savings plans in the next few years. These are plans that let families sock away money in mutual funds and withdraw money tax-free for school-related expenses.

But now there are several factors at play that could negatively impact the market. The government’s massive spending cuts over the next decade could also weaken the economy.

To factor in room for such turbulence, families often invest in target-date 529 plans that are designed to grow more conservative as the student nears enrollment age. But the mix of allocations can nevertheless vary depending on the investment manager. So for peace of mind, families may want to call their planners to check that their savings are appropriately allocated.


Candice Choi can be reached at www.twitter.com/candicechoi .