PRICING STUDENT LOANS
March 17, 1998
As the cost of higher education continues to go up, more and more students are taking out student loans. Congress has set a new lower interest rate, which may increase the allure of postponing the costs of college. But will the banking community cooperate? Phil Ponce talks with the experts.
PHIL PONCE: More than 5 million students taken out college loans under federal programs, and the cost of taking out these loans could be dropping significantly. That's because the interest rate on government-guaranteed student loans is set by Congress and under the law, the interest rate is scheduled to drop come July 1st.
A RealAudio version of this segment is available.
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The Department of Education home page.
Under the current formula, students pay an interest rate of just over 8 percent. But as of July, a new formula is set to kick in, which would lower the rate to about 7 percent. That new interest rate, private lenders say, would be far too low. They administer about 70 percent of current student loans, and lenders say if that new rate goes into effect, they will stop making as many loans, or stop making loans altogether. An attempt by the administration to come up with a compromise has failed, and tomorrow this all comes up before a House subcommittee.
Joining us now with more on the issue are: Marshall Smith, Acting Deputy Secretary of Education, and Jon Veenis, chairman of the education funding committee of the Consumer Bankers Association. Gentlemen, welcome. Mr. Smith, why does the administration support a lower rate?
The administration supports a lower rate.
MARSHALL SMITH, Acting Deputy Secretary of Education: Well, for two reasons. First of all, this is a guaranteed loan program, and guarantee means two things in this case: One, every student in the country can get one if they need one for school, and two, there's a guarantee by the government to the banks, so that if a student defaults, the banks get 98 percent of the original principal plus whatever accrued interest occurs over that period of time. Now, why do we look for a lower interest rate? We're looking for a lower interest rate, No. 1, to give students access to college. All students need it in this country. That's the greatest investment we can make in our youth, and this gives them a better chance to get in. Over a period of five years, the interest rate that the administration has proposed would save $11 billion compared to the interest rate in effect right now, $11 billion. For a student that takes out about a $20,000 loan or a series of loans that add up to $20,000, that student would save $1,000 over a period of time.
PHIL PONCE: Right now, relative to other loans that are out there on the marketplace, what's the comparison?
The Internet reveals competing interest rates.
MARSHALL SMITH: Well, we looked it upon the Internet, which is a wonderful, wonderful mechanism to do this stuff. Mortgage rates are--for houses are roughly 7.3 to 7.4 percent. The rate on cars--car loans are about 7.5 percent. What we're proposing is 7.0 percent, but we're proposing it on a guaranteed loan. There's no risk, so very different than exists for housing mortgages or for car loans.
PHIL PONCE: How about that, Mr. Veenis, one can get a mortgage for 7.1 percent and a car loan for 7 3/4, why not lower rates for student loans?
JON VEENIS, Consumer Bankers Association: Well, I think there's two fundamental points to keep in mind here. First of all, the student rate effectively is lower than the rate even that Mr. Smith quoted because of two factors: First of all, in many cases students will qualify to have the interest paid for them while they're in school, and second, beginning in 1998, actually, student loans are tax deductible for the first five years--the interest. So for many students, the effective rate will actually be less than 5 percent. Second point, mortgage loans are dramatically different than student loans. With a mortgage loan at the time the loan is taken out, the borrower has income; the borrower has assets. We know where the borrower is at. But a student loan, the loan does not go into repayment for several years, until the borrower leaves school. Many times, the borrower is trying to settle in and may be transitory. It's hard to reach them. And so our loan servicing costs for those student loans are much higher than what they are with mortgage loans, plus the fact you're talking about a $3,500 student loan, and you may be talking about a $130,000 mortgage loan. Again, your servicing costs are dramatically different.
Comparing student loan rates with rates for cars and houses.
PHIL PONCE: How about that, fundamental differences between student loans and loans for houses and cars?
MARSHALL SMITH: Oh, I don't think so. One of the things that happens is that the banks give out the loans, give out the loans, and then they sell the loans to servicers, so they don't have to absorb the cost over a period of time. But the second thing is we're not really talking about the rate to students so much. I think that issue has been settled pretty much. The administration's proposal has been accepted by the House, and I believe the House will vote on it tomorrow, and we'll actually come out with a rate of about 7.0 percent. The lenders Jon represents have proposed 7.65 percent, a big difference in the rate of lending. The House proposal is around 7.5 percent. The administration went in and took a look at what a fair rate would be, that is, the Treasury did a study. That's the only really empirical study that's been done on this so far, and they came out with a range of between 6.9 and 7.3 as the interest rates, which would give a fair and competitive rate to the banks and to the other lenders. And what we've done is proposed something inside of that band. Both the House proposal and the bank proposal are outside of that band; they're above it.
PHIL PONCE: Mr. Veenis, what is a fair rate for bankers to earn?
JON VEENIS: Well, let me refute a couple of things that Mike stated. First of all, these loans are not risk free. There is a government guarantee on the loans; however, there is significant servicing risk. We have stacks of regulations that we need to comply with to make certain that the loans stay in compliance and the guarantee stays in compliance. If you come out to our shop in Sioux Falls, South Dakota, I can show you a lot of people servicing a lot of loans, but they're there because of the regulatory burdens that are involved in making certain that the guarantee stays on the loan. So what's a fair rate? I think the only way that we're really going to determine this is through market type measures to make certain that the rate is competitive in the marketplace. I don't know that Congress knows what that rate is. I don't know that I know what that rate is. The market knows what it is. I know that in today's--today's government-guaranteed loan program there's price competition, and price competition will continue to set the rates.
PHIL PONCE: So even now, with the limit at 8.25 or whatever it is, there is competition even now?
JON VEENIS: Absolutely. What you effectively are doing with today's rate formula is you're setting a ceiling, and the competitive marketplace is driving that rate lower. I'll give you an example. Today borrowers, many lenders offer borrower discount programs, where if lenders--if the borrower makes 48 consecutive payments, we'll reduce that borrower's rate by 2 percent at the time that the 49th payment is due. That's a significant benefit to the borrower. That, in effect, reduces the cost to the borrower, so there is price competition in today's marketplace.
Will banks bow out of the loan business?
PHIL PONCE: What are banks going to do if the rate is lower than what you're willing to sign off on?
JON VEENIS: It remains to be seen. As Mike said, there's a number of proposals on the table. We don't know exactly where this issue is going to end up. We do know that if the administration's proposal takes effect, that there's going to be serious harm to the government-guaranteed loan program.
PHIL PONCE: And that means some banks are going to stop making as many loans, or some banks are going to make loans altogether?
JON VEENIS: That could be one of the outcomes.
PHIL PONCE: How seriously does the administration take that?
JON VEENIS: It takes it very seriously, and that's why we had the study done. That's why we're looking forward to seeing the study that comes out of the Congressional Budget Office, which looks at the Treasury study. We believe that we've set our rate, that is within a reasonable range, and that it's not going to affect the supply very much, but if it does affect the supply, we have a contingency plan that could go to work immediately. There are in the law lenders of last resort--the Sally Mae Corporation, which deals with huge numbers of loans every year--and a lot of the other agencies that exist in this loan program are ready to step in and take over an awful lot of the lending if certain banks step out. So we believe that we've covered every contingency in this; that we've got a fair rate, a fair rate for banks. We've got a very fair rate for students. We believe this proposal is very strong, and we'll see a lot of attention paid to it in the Senate, in particular.
Contingency plans exist to pick up the slack.
PHIL PONCE: Mr. Smith, you said that you have these--this contingency plan waiting if certain banks step out. What if a lot of banks step out, can the government make up--can the administration make up the slack somehow?
MARSHALL SMITH: Well, Jon talked about the kinds of loans that are more preferable to the banks, that is, larger loans and loans from people that they see as more stable and in some way that is more likely to be able to repay easily so that the servicing costs aren't as great. A large percentage of the students in this country are exactly that--in exactly that situation. The--all the students in four-year colleges and private colleges and so on, most of them are in those situations.
They have fairly large loans over a period of time, and they do pay their loan costs. There are another set of students that often are poor, can't absorb some of the costs, and actually often have smaller loans. Those loans aren't as attractive. We believe that we need to make absolutely certain that every one of those students will be eligible to get a loan.
PHIL PONCE: Mr. Veenis, tomorrow, the House subcommittee is going to propose this interest rate in the range of 7.9 percent or so. How low are the bankers willing to go, and is this 7.9 percent rate, is that something that your members would agree to?
JON VEENIS: We still find problems with the House proposal. Our concern is this: The current program, the guaranteed loan program, works very well. Every student that needs a loan can get a loan. There's price competition. Lenders continue to invest in technology. You can go out today, if you have a student loan, and log onto the Internet, and you can put in your Social Security number and a pin and you can get information about your loan. Those types of technology investments will go away if the cuts are too low. We want to continue a strong government-guaranteed loan program; we want to make certain that all borrowers can have access to a loan program, and our concern is that these types of cuts that are being proposed will not allow for a vibrant, robust, guaranteed-loan program.
PHIL PONCE: Gentlemen, we'll have to leave it. I thank you both very much.
MARSHALL SMITH: I disagree with that. The investment that will be made in order to compete in the market will, in fact, enhance the service quality that goes out to the students.
PHIL PONCE: With that, we'll have to leave it. Again, thank you both.
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