Borrow More Now! Pay More Later!


The 2006 federal education budget proposal, released in detail earlier this month, is a lot like Jon Stewart—smaller in real life than it looks on TV. President George Bush touts a $100 annual increase in Pell Grants for the next five years, but the grants in real dollars are worth some $800 less than they were in 1975. Meantime, he proposes eliminating specialized programs aimed at increasing college access for poor, minority, and other underserved students, and a thousand other cuts for an overall budget decrease of 3.7 percent.

The Greatest Generation had the G.I. Bill to pay for college. Baby Boomers got the Pell Grant program in the 1970s, and back then it paid for an average of 50 percent of a public university education, compared to 25 percent today. Students these days are supposed to be grateful that Bush’s new budget will allow them to borrow even more, raising the annual limit on federal student loans from $2,625 to $3,500 for freshmen.

That’s troubling news to Donald Heller, of the Center for the Study of Higher Education at Penn State, who has testified before Congress on student aid and access to education. Heller cites new data showing students graduating with average debt approaching $23,000. “There are a number who are paying back more,” he says.

And if the Bush budget goes through, the cost of any given student loan might end up doubling. That’s because he is proposing to eliminate fixed interest rates for consolidated federal student loans; the Republican chair of the House Committee on Education and the Workforce has already introduced a bill to do just that.

“It’s obviously going to make it more difficult for those students, if they have been taking advantage of consolidation to make their loan payments easier,” Heller says. The bill wouldn’t save the government money right away, but it would cost some of the more vulnerable students more. Typical consolidators are young—60 percent are under 35—and have fairly low-income jobs, like nursing or teaching. They’re looking to avoid riding the track of variable rates, and are willing to endure a lengthy payback period in exchange for manageable—and predictable—monthly payments.

Fluctuating interest would alter that deal significantly. The average $20,000 student loan burden, locked in at today’s low rates, costs around $7,700 in interest. If rates eventually peak at 7 percent, as forecast by the Congressional Budget Office, that interest bill would go up to $17,000, rivaling the amount you borrowed in the first place.

Michael Eaton, 35, retired from the army as a sergeant. He attended Texas A&M for a bachelor’s in accounting and a master’s in management and information systems, and is currently working on a law degree at George Mason University. A few months ago he consolidated his 16 student loans, a total of $90,000 from both the federal government and private lenders, at 4.375 percent with Citibank. His single monthly payment is now just $475. “Over the long haul it’s pretty safe to assume that interest rates have nowhere to go but up,” he says. “I would tend to oppose [variable-rate consolidation]. It could really cost me.”

In recent years, with Federal Reserve Chairman Alan Greenspan endorsing record-low interest rates, millions of grads like Eaton have signed up for federally backed student loan consolidation. A student can consolidate several loans from separate lenders into a new loan with a super-low rate, currently at 3.375 percent.

Consolidations have tripled in the past four years, to $43.7 billion in fiscal 2004, and such loans now make up about a third of the total annual volume of student debt. Yet with interest rates so low, the government is currently collecting more in fees from people wishing to consolidate their debt than it is paying out in interest subsidies.

More third-party consolidators have gotten into the biz, swiping some of the traffic from banks, and so incentives from competing lenders can slash some rates as low as 1.65 percent, pretty close to free money. Crucially, these rates are fixed over the life of the loan, making for predictable, low payments. The federal government makes up some of the difference to lenders when market rates bump higher.

If the system works so well, why is Bush in such a rush to change it? Well, the big banks and loan brokers like Sallie Mae don’t like competing with, they don’t like paying special fees to the government on consolidated loans, and they especially don’t like losing the points between 3.375 percent and 8.25 percent, the current maximum rate on variable-interest student loans.

The good news for students is that Bush has tried and failed at this particular measure before. His proposal to eliminate fixed-rate consolidation in 2002 was backed by the Consumer Bankers Association, but all 22 Democrats on the House Education Committee signed a letter opposing it, and Bush quickly backed off. “We plan to keep reminding everyone we can that this is going to make college more expensive for students,” says Tom Kiley, spokesperson for Congressman George Miller, the ranking Democrat on the House committee.

The best advice for current student loan holders? Consolidate now—and write your representative.