Yesterday, Senator Elizabeth Warren (D-MA) introduced legislation aimed to help level the playing field for student loan borrowers.  The main goal is to lower interest rates on ALL student loans (Fed and Private) to a fixed amount for the duration of the loan term.  The theory being that if interest is lowered, payments would be more affordable.  It is a response to the obscene profits the Government makes from the varied interest rates on Federal loans.   It would also bring Private loans under control of the Feds.  The interest rates would be as follows:

• Undergraduate Stafford loans – 3.86%
• Graduate Stafford loans – 5.41%
• Parent and Graduate PLUS loans – 6.41%
• Preexisting Consolidation loans – 6.41%

The best way to break this down is Clint Eastwood style: The good, the bad, and the ugly.

The Good

Under BSELRA (terrible acronym), Private student loans (PSL) would be eligible for consolidation under the Federal program.  In other words, folks with private loans could refinance at the same interest rate for similar federal loans, with no limit on the amount financed.  Undergraduate PSL would be 3.86%, while graduate PSL would be 5.41%.  Both winners in my book since the average interest rate I’ve seen on PSLs is about 10%.

The best part of this Act is what it does for PSL co-signers (typically parents or grandparents); it gets them off the hook.  The student borrower can refinance the private loan through this program without including the co-signers.  AWESOME!

A smart detail included is that any time already accumulated towards forgiveness, be it the 10-year PSLF or 25-year IBR/ICR, will be counted.  Normally that time is lost when a borrower consolidates a loan, but that doesn’t happen with this program.

Let’s not forget the point of this Act – the interest rates.  I’ll say the undergrad and grad interest rates are good as is the rate for PLUS loans.  I’ll talk about the 4th situation elsewhere, because I do not think it fits under “good”.

The Bad

What makes this Act useless is the eligibility for PSL refinance.  Only PSLs in good standing are eligible.  All those borrowers in default gain no benefit here – which is a true failure of this act.  Those in default are the folks who need this most.  I’ve seen PSL monthly payments in excess of $500.  When a person pays more for a PSL then a car, there is a problem.  Unfortunately, BSELRA does nothing to address these poor souls.

PSLs refinanced under this act do NOT qualify for Public Service Loan Forgiveness (PSLF).  I put this under bad even though there is no reason why it should be.  Lenders get the benefit of a quick payoff.  The only way the Government can make back the money is to refinance it longer to collect on the interest.  And since the newly refinanced loan qualifies for all Federal repayment plans, this isn’t that much of a downer.

What will be interesting to see is if PSL lenders will hold off or even reverse defaults (perhaps allow a quick cure plan) to make more folks eligible.  After all, if the lender isn’t getting paid by the borrower (thus defaulted), why not find a way to get a quick payout through this program?  I don’t think PSL lenders will entertain this idea, but they should (it would make their investors very happy to see a return on money).

The Ugly

As already stated, those most in need may not necessarily benefit from BSELRA.  Those on a low income already benefit from IBR.  The interest rate on these loans is irrelevant because the payment is based on income, irrespective of the balance owed.  Further, those with a low income have already or are very likely to default on any PSL they have before this Act can be enacted.  That means their PSL will not qualify for refinance.

Another ugly issue is the interest rate for preexisting consolidation loans; a fixed rate of 6.41%.  Currently, consolidation loans get a weighted average of the interest rate of all the loans being consolidated.  Many folks I work with have interest rates at or lower than the 6.41%.  This part of the Act seems to penalize folks for consolidating prior to the Act, which makes no sense to me.

How long will this program last?  According to the Act, when the cost of the program exceeds the revenue generated by it (profit from interest).  That makes sense, but the real question is, when would that be.  I’m not an economist, though I would love to see a projection of when equilibrium might be achieved.

Another ugly; only loans taken out prior to July 1, 2013.  Sorry class of 2014, this last year of loans are not eligible for this program.  Then again, if you took out a PSL recently, you haven’t researched enough.  For those not yet trapped by PSLs, pick a different school instead of borrowing PSLs.

The Ugly Ugly

Talk about leaving an ugly mess, lets look at the eligibility requirement: “…the Secretary [of the Department of Education] shall establish eligibility requirements based on income or debt-to-income ratio that take into consideration providing access to refinancing under this section for borrower’s with the greatest financial need.”  WHAT?  I’m not sure what that means, but it doesn’t look pretty (thus ugly).  This is as clear as the current language allowing student loans to be discharged in bankruptcy for “undue hardship”.  Without clearer instruction or definition, this is sure to be screwed up and miss the mark.  Even worse, there is no way to sue the department when it fails (well there might be, but it will be really hard!).

My Thoughts

I think this legislation is a good first step.  Refinancing private loans is perhaps the best piece of this.  The interest rate fix I think is actually a red-herring.  I’ve already written about student loan interest rates being immaterial for repayment in a special publication (Understanding the Current Loan Landscape).  Those who pay their loans with IBR will not pay the balance off.  Instead, there will be forgiveness – the amount is determined by the interest rate.  I guess lowering the interest does help the Government forgive less, and that can’t be bad.

What would really help student loan borrowers would be a tag team effort to pass Senator Durbin’s  (D-IL) bill to strip out bankruptcy protection for PSLs.  Then people have a choice of how to handle their PSLs.  Further, those in default on their PSLs who cannot benefit from BSELRA would have bankruptcy as a last resort.

Make a Difference

This is just a bill…on Capitol Hill.  If you support it, make sure your Congressman/woman hears from you.  Political action is vital if you want a change in the student loan industry.  Very few folks are unaffected by student loans.  If you’re reading this, you’re not one of those folks.  Make a difference, be heard.