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Summer Student Loan Agreement: Not Much Help There

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This post was co-authored with Ron Miller, FSS

Full disclosure: Neither author nor any member of their families has any outstanding student loan debt. Kunstler's $5,000.00 loan incurred during grad school in the 1980s was fully repaid some 25 years ago.

It's that magical season when the thoughts of returning college students and their parents turn to tuition. Given the size of student loans, those thoughts are apt to linger long past graduation.

This summer, Congress and the president struck an agreement to defer an interest-rate hike for undergraduate loans. The agreement, however, simply defers for 12 months doubling rates on undergraduate loans from 3.4 percent to 6.8 percent. Otherwise, it actually increases college costs. Next summer the whole question will be revisited, perhaps this time with Mitt Romney as president.

The agreement's less publicized elements include the following:

The 3.4 percent rate is temporary. In twelve months the rates will double despite the historically low cost of funds available to all lending authorities. Applicable Federal Rates (AFR's), set by the IRS, are the minimum acceptable interest rates used as a starting point for many loans. The IRS issues them monthly in a Revenue Ruling prescribing short-term (0-3 years), mid-term (3-10) and long term (10+) rates. Rates are based on the average market yields on outstanding marketable obligations of the U.S. relative to their specified terms. Student loans are based on the Long Term AFR, which for September 2012 is 2.23 percent annually. How can it be considered a victory to "hold" interest rates on student loans to "only" 3.4 percent? Where did the 6.8 percent number even come from?

Graduate Student Stafford Loans will no longer be subsidized, meaning all grad rates will now be 6.8 percent. The subsidized rate in 2011-12 was 3.4 percent; a year earlier it was 4.5 percent. Unsubsidized loans were 6.8 percent both those years, but the subsidized loans were geared specifically to those with financial need. Thus, for those with the greatest need, the Stafford Loans have doubled. In addition, loss of the subsidy means that any grad school loan taken out on or after July 1st 2012, even by current grad students, begins accruing interest immediately rather than after graduation.

Grace period -- gone. Prior programs included subsidized interest payments while in school and a six-month grace period after school. These grace periods have been abolished.

Repayment incentives intended to encourage early loan repayment no longer exist for loans originated on or after July 1, 2012. The agreement ends the Department of Education's incentives that encourage on-time repayment, including reductions in the interest rate or origination fee. As a result, the up-front interest rebate available to Direct Loan borrowers will no longer be offered on loans whose first disbursement date is after June 30, 2012. Direct Loan borrowers who agree to have payments automatically debited from a bank account are still eligible for incentives.

Harder to receive the maximum. Other changes limit the amount of funding available, restrict the number of eligible semesters, and generally make it more difficult to qualify for funding. Halfway through college and no longer eligible for a loan? Try again next year... maybe.

As a society, how can we justify 6.8 percent when the IRS's own computation of acceptable market interest rates is only 2.23 percent? Even 3.4 percent is absurdly high. We urge people to invest in education, yet we make the cost of that investment utterly exorbitant.

Critical jobs with great career promise, such as Licensed Practical Nurse (LPN), Pharmacy Assistant, Plumber, Electrician, or Computer Technician are being priced out of reach by rising tuitions. Higher interest rates could hamper many lower and middle income families from affording these less expensive programs.

For example, the cost of a two year AAS Degree program for LPNs at Blue Ridge Community College in Virginia is $19,015. Over a student loan's 10 year term, 6.8 percent interest adds $3,802 to the cost of interest. A two year Computer Tech degree costing $22,775 shows a $4,553.00 difference between the two rates. The respective total interest charged on the two programs stand at $7,244 and $8,676 respectively. Not a lot by today's standards, but still an important bite out of a young person's early income, especially as they are repaying the entire tuition of about $20,000 plus interest, not including books, room, and board.

For bachelor's and graduate degrees, the costs skyrocket. A typical state university, for in-state students, costs (roughly and with great variation), about $20,000 per year for tuition, fees, and room and board. This may seem reasonable when set beside private schools whose comparable rates can reach the $55,000-$60,000 per year range. However...

State universities were established to increase access to higher education for the poor and middle-class. Twenty thousand a year is unaffordable for many middle class families and often impossible for those with more limited income. Many of these families resort to loans which, if they cover only half the expenses, can amount to $40,000 by the end of a four-year program. A student taking out loans for the full cost and then for two years of graduate school will owe well over $100,000.

For out-of-state students attending public universities, the cost can easily equal that of private colleges, i.e., $35,000-$60,000 per year. A State U. education can be as good as the more expensive private colleges' but the latter do have attractions that lead many students to select them. The multi-tiered pricing system, however, means that education at the best schools, including higher ranked public institutions, are becoming accessible only to the well-to-do. Even for a two-child family earning $150-200,000 a year, the cost of college at a high-priced public or private college comes to half a million dollars for both kids, an amount that can ambush even the most careful financial planning. So how is a family only earning the national median household income of $51,914 supposed to attain a decent education?

What does this mean in terms of numbers? Let's say after undergrad and grad school, a student owes $70,000.00. That is high for many people, but low for many programs. It can represent less than half the total cost of an undergrad education at a private or out-of-state public university. With the 6.8 percent rate, $70,000 would incur monthly payments of $805.56 over a 10-year term, including $26,667.20 interest. That would require yearly earnings of almost $65,000 if 15 percent of gross earnings were applied to the loan. Few new graduates can remotely afford that. If the term were increased to 30 years, one available option, total interest would rise an additional $67,618.40.

At 3.4 percent, the 10-year repayment would require $688.93/month, a total of $12,671.14 interest, and an annual salary (at 15 percent of gross income) of $55,114.40. A 30-year extended payment plan would cost almost $30,000 extra. At a reasonably subsidized rate of 1 percent (reasonable considering the IRS's 2.23 percent AFR) the number shrinks to $3,587.45 interest paid, total annual salary of $49,000, and $7,500 added for a 30-year term. It's the difference between financial stability and being a debtor for years.

Virtually every professional and paraprofessional position requires a college degree. The higher education industry stands in an extortionate relationship to potential students. "You want a job or career, then pay us." For colleges, part of the financial aid process is encouraging students to take out loans because student borrowing guarantees tuition income for the college and relieves the pressure to offer scholarships. The college's interests are by no means always aligned with the interests of their students.

The disconnect between tuition rates and income is vast. The National Center for Public Policy and Higher Education states that from 1982-2007, tuition and fees rose 439 percent while median family income rose only 147 percent. Much of the latter number went to the wealthiest among us.

Despite higher education's flaws, it is still critical to the economic, social, and even mental well-being of both individual and community. Choosing to attend a college, and choosing which to attend, is an important decision full of hope and promise. Unfortunately it can lead to economic purgatory.

The July agreement may have been bipartisan, but the two political parties have dramatically different approaches to the problem of student debt. In June, 2011, the White House announced a new partnership with the National Association of Manufacturers to provide 500,000 community college students with "industry-recognized credentials." Some of those credentials could be earned in months rather than years and place people in well-paying jobs manufacturers have been struggling to fill.

Meanwhile, Democratic Representative Hansen Clarke of Michigan proposed a Student Loan Forgiveness Act with provisions for capping payment versus discretionary income, debt forgiveness, a 3.4 percent cap on interest rates, and rollover of private loans to federal so they can qualify for the Act's provisions. The bill will never be passed by a Republican-controlled House of Representatives.

This debt is not just crippling our students' futures, but America's as well. At a time when we haven't really recovered from the economic meltdown of 2008 and with employment scarce for recent grads, debt relief will release hundreds of billions of dollars into the hands of young people struggling to get started in the world. It will also relieve their families of debts that threaten their retirement, mortgages, and health.

True, such debt relief would be a cost transferred to the government and other guarantors of the loan. We believe, however, that its economic benefits and the intrinsic long-term value to our society would make this by far the most beneficial of recent bailouts the government has enacted.

We could cancel all student debts tomorrow and it would just be a hiccup in the national economy, a fraction of the money pumped straight to the banks' coffers in the bailouts of the past four years. Long-term, such a step would release the earning and purchasing power of two generations of students and stimulate economic growth well beyond the cost of the original debt. Perhaps then we can turn to the task of making college available to all qualified students and bring the cost of college into alignment with today's economic realities.

Ron J. Miller, FSS, is a Financial Services Specialist and founder of All-in-One Financial Services. As a Retirement Counselor, Tax Preparer and Estate Planner, Ron recognizes that peace of mind and financial security requires planning across a family's generations. As a native of New York City and resident of North Carolina, he has been a close follower of the political scene all his life and its impact on the daily lives of everyday Americans. As a writer he hopes to shed light on one of the abiding mysteries of American life: how a people so aware of the power of money can often pursue political objectives so contrary to their financial interests.