Obama touches on student loan interest rates

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NEW YORK (AP) ? President Barack Obama’s State of the Union speech Tuesday night may be causing anxiety for families with college-bound students. In addressing the rapidly rising cost of higher education, Obama noted that the fixed interest rates on student loans are set to double in July if Congress fails to act.

Here’s what’s behind the change referenced by Obama:

THE BASICS

There are primarily two types of federal student loans: subsidized and unsubsidized. The difference is that the government doesn’t start charging interest on subsidized loan until the student graduates.

With unsubsidized loans, by contrast, interest starts accruing right away. That can tack a considerable amount on to the initial loan amount by the time the student graduates and starts paying off the debt.

Borrowers also pay a different interest rate when they graduate. Unsubsidized loans currently charge a fixed interest rate of 6.8 percent. Over the past few years, the interest rate on subsidized loans was gradually lowered to its current level of a fixed 3.4 percent. The reduction was the result of legislation passed before the financial crisis that was intended to reduce the cost of college. But the law established the 3.4 percent rate only through this July.

So unless Congress extends the reduction, the rate on unsubsidized loans would go back to 6.8 percent.

THE BACKGROUND

A little less than half of all undergraduate students have a subsidized federal loan, according to Mark Kantrowitz, publisher of Finaid.org, which tracks the student loan industry. And not everyone who gets a subsidized loan is from a low-income household,

Eligibility is based on financial need, which is determined by a formula on the Free Application for Federal Student Aid. So students from relatively well-off households could qualify for a subsidized loan if they’re attending an expensive school.

Even though subsidized loans are widely used, the current budget shortfalls make it unlikely that lawmakers will extend the 3.4 percent interest rate on subsidized loans, Kantrowitz said. A greater focus will likely be on preserving Pell Grants, which are critical in helping the neediest students attend college.

“Letting the interest rate go up is the lesser of two evils,” said Kantrowitz.