Florida Congressman Proposing Changes to Federal Student Loan Interest Rates
Federal student loan interest rates rose July 1st of this year, marking the first increase in several years. Last week, Al Lawson, D-Fla., introduced a bill to address the growing student loan debt problem.
Similar to a bill introduced in May, Lawson’s Student Opportunity Act proposes four things:
- Offers to refinance federal loans
- Changes the interest rate formula
- Eliminates origination fees
- Eliminates the tax penalty for loan forgiveness in income-driven repayment plans
Currently, student loan borrowers cannot refinance their federal student loans without transferring them to the private sector and losing borrower protections. The Student Opportunity Act would allow students with loans originated before July 1, 2010, to refinance to a lower interest rate that is calculated using the new formula.
Interest Rate Formula
Student loan interest rates are calculated based on 10-year Treasury notes, which are auctioned each Spring. Currently, 2.05% is added to the Treasury note yield to determine the undergraduate interest rate. For example, this year the Treasury note yield was 2.4%, so the interest rate for undergraduate loans is 4.45%. The interest rates are capped at 8.25%.
The Student Opportunity Act would change the formula to add only .5% to the yield of the 10-year note. If this were in effect this year, the interest rate would be 2.9% instead of 4.45% for undergraduates. Additionally, the rate cap for undergraduate loans would be capped at 8.5%.
The following table outlines the differences in how the interest rates are determined in the current formula versus the formula proposed in the Student Opportunity Act, based on the Treasury note yield.
Currently, all federal student loans come with an origination fee that is taken when the loans are disbursed. The current rate of 1.066% of the loan means that for a $10,000 loan (for example), $106.60 would be subtracted for the origination fee and you would see $9,893.40 of your promised loan amount.
For PLUS loans the rates are higher, at 4.264%. For that $10,000 loan, $426.4 would be removed for the origination fee and you would only see $9,573.60.
The Student Opportunity Act would eliminate those fees so the amount students are offered is the amount they get.
Loan Forgiveness Income Tax
There are several student loan forgiveness programs with varying requirements, and many boast tax-exempt forgiveness. Borrowers who are not eligible for those programs take advantage of the income-driven repayment plans (PAYE, REPAYE, IBR, ICR, and ISR). After 20–25 years of paying a portion of their income, borrowers will get the remaining balance forgiven.
However, any balance forgiven at the end of IDR programs will be taxed as income.
That taxed amount can be a huge burden on someone who depended on an IDR plan to get through their student loan debt. The Student Opportunity Act would prevent the forgiven balance from being taxed as income.
With 12 cosponsors, Lawson has high hopes for his bill. He said, “Education is a fundamental facet of the American dream. Across the country, students attend colleges and universities with the hopes of climbing the economic ladder, providing for their families, and working to meet new challenges with ingenuity and expertise. … Reducing student debt will help increase economic activity and provide our nation’s students with the relief and opportunity they deserve.”
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