Since 2010, all federal student loans have been issued by the Department of Education at fixed interest rates. The rate you get depends on the type of loan you take out, and the differences in the rates at first glance are counterintuitive.
For undergraduate education, the rate is currently 4.29%. For graduate education, if you are borrowing for yourself, the rate rises to 5.84% for the first $29,000 you borrow annually. If you need more money for school, or your parents are borrowing to help you pay for school, the rate rises again to 6.84% through the “PLUS loan” product. These rates are determined by adding a fixed charge to the 10-year Treasury note each May for the following July 1 - June 30 period.
Additionally, PLUS loans carry an onerous 4.272% origination fee that’s subtracted from the disbursed amount, compared to the 1.068% origination fee on undergraduate loans. All in, this means that graduate students or parent borrowers will pay an additional $3,330 over a standard 10 year horizon to fund $20,000 in education expenses with PLUS loans.
The differences in rates and fees brings up important points about the system worth exploring. Though the rationale for the rate difference is not articulated anywhere in the Office of Financial Aid’s materials, it’s clear that higher cost graduate loans and loans to parents (almost always more creditworthy than their children who are just starting out) are pegged at higher rates to subsidize direct undergraduate lending. Student loan default rates currently stand at 14%, and the vast majority of these defaults occur at the undergraduate level.
In the private market, a stronger credit profile will yield a lower interest rate, not to mention that most private lenders do not charge origination fees for student loans. This discrepancy is causing many borrowers to seek private options for student loans, or to refinance their federal student loans at a lower interest rate once they have graduated.
Instead of having the desired effect of providing reliable income to cover riskier undergraduate lending, the best borrowers end up fleeing the system and cause the overall portfolio to become riskier. Though not the biggest student loan issue facing us today, the interest rate structure is indicative of a system that was cobbled together and not sufficiently evaluated before being launched in the wild. It’s a $100 billion annual and $1.1 trillion total experiment that is troublingly slapdash and full of unintended consequences.
