08/15/2013 10:31 am ET Updated Oct 15, 2013

The Good, the Bad, and the Ugly in the Student Loan Deal

Over the past several weeks, the Bipartisan Student Loan Certainty Act has made its way through the Senate, the House, and on to the president's desk for his signature. The new law is a 10-year plan that was billed as making student loans affordable.

But it is impossible to reduce the student-debt burden without answering two key questions:

What is the cost of running a student-loan program?

And which interest rate is the best for running a student-loan program?

Unfortunately, the most recent loan-reform debate left both of these questions unanswered. Fortunately, the new law calls for a study to find answers. Only once that has happened will congressional and administration leaders be able to hold an informed debate to reach a fair plan.

Student loan debt has topped credit card debt as the top form of consumer debt across the nation, at $1.2 trillion and growing. Potentially adding to that debt, on July 1 student borrowers of new subsidized federal Stafford loans saw their rate double from 3.4 percent to 6.8 percent.

In what was sold to the public as a reversal of that rate hike, the new student loan deal will indeed cut interest rates in the near term. But within two years, rates are expected to rise higher than the rates borrowers pay under current policy. While the new law contains a few concessions to struggling borrowers, on the whole it is harmful.

Let's take a look at the good, the bad, and the ugly in the new law.

The Good
The deal looks really good in the short term for borrowers. Ultimately, the need to deliver on low interest rates right now, especially for undergraduate borrowers, was what drove policy makers. Rates will be set at 3.86 percent for this year for undergraduate Stafford loan borrowers. Graduate Stafford borrowers will see a rate of 5.41 this year, and PLUS (parent and graduate student) borrowers will see 6.41 percent.

Rates for new loans will be tied to Treasury bond rates, which worried consumer and student groups that did not want to expose borrowers to limitless interest rates. In response to this concern, the deal sets rate caps at 8.25 percent for subsidized and unsubsidized undergraduate Stafford loans, 9.5 percent for graduate Stafford loans, and 10.5 percent for PLUS loans. These caps are high enough to still expose students to dangerously steep interest, but nonetheless, the caps are there.

Many student groups have agreed that a market-based rate is reasonable, but that it must be tied to the government's cost of lending and it must have a meaningful cap to protect students from high interest rates. Yet we still don't know which index is the best proxy for the government's cost of providing student loans. We can improve student loan policy in the future once the study is complete.

The Bad
The deal is designed to be "revenue neutral" over the next 10 years. That means that the low interest rates given to students now must be balanced by higher rates down the road. In essence, the law forces today's 13-year-olds to take on extra debt when they go to college, all in order to pay for the cheap loans being offered for borrowers over the next several years.

Under the new law, five years from now an undergraduate who takes out the maximum in subsidized and unsubsidized Stafford loans will most likely pay $4,700 more over the life of the loan than she would have last year -- and $900 more than if Congress had done nothing and the 6.8 percent rate had simply stayed in place, according to an analysis by the Institute for College Access and Success.

It's bad enough that future undergraduates will end up with more debt under the new law, but they make out much better than graduate students and PLUS loan borrowers (who are mostly parents taking on loans to help their kids). The Institute for College Access and Success predicts that a graduate borrower who takes out unsubsidized loans over the next two years will save $3,600; however, a grad student taking out the same loans five years from now will assume $7,700 more debt than if Congress had left the fixed rates in place. Similarly, a parent borrower right now will save $2,100 on a typical loan of $17,000, but a parent taking out the same loan five years from now will pay $2,750 more than under the fixed rate.

The Ugly
Despite efforts by Sen. Elizabeth Warren and Sen. Jack Reed to move the debate in a direction that would actually lower student loan debt, Washington's political establishment largely ignored the deeper problems with the student loan system. According to Senator Warren, the entire student loan system is expected to make more than $184 billion in profits for the federal government over the next 10 years.

The government should not be profiting by sending students deeper into debt. Yet, incredibly, with passage of this new law, the federal government will extract an additional $715 million from borrowers on top of that $184 billion. These funds will be diverted toward deficit reduction, effectively trading more student loan debt for government debt.

For decades, student and consumer groups fought the huge subsidies that banks received from the federal government for their participation in student lending, delivered in the form of special allowance payments, borrower fees, and interest that amounted to staggeringly high profit margins for the banks. Banks were finally removed from the student loan program with passage of the Student Aid and Fiscal Responsibility Act in 2009.

Now, with passage of this new law, Americans have lost a major opportunity to roll back the staggeringly high profits that the student loan system generates for the federal government. Ideally we can re-engage on this key policy question once the results of the study are public. Education is an investment in the social and economic health of the country, so lawmakers should be making student loans as affordable as possible.

Education Secretary Arne Duncan has repeatedly said that college affordability is a priority for this administration. Now it's up to Secretary Duncan and Congress to act before this new plan's high interest rates kick in, and to pass real reform that keeps college within reach for students and families.

This piece originally appeared in The Chronicle of Higher Education.