Student Loan Loophole

Back in 2005, the Wall Street Journal and the Washington Post reported that Congress was going to once again try to close a student loan loophole that's existed since the 1980s. This isn't the first time Congress has tried to close this loophole.

History of the Student Loan Loophole

If you're old enough to remember the 1980s, then you know about the double digit interest rates that existed back then. We're not just talking 10%, were talking 6-month Certificates of Deposit that yielded over 18%. Interest rates were high, and that made borrowing expensive, especially for college students looking to borrow money to pay for college.

Student Loan Interest Rates

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At that time, Congress passed a law that encouraged banking institutions to lower interest rates on student loans to 9.5%, in exchange for guarantees against default on the loan. By removing the risk of default, banks were guaranteed 9.5% on the loans they wrote, not a bad deal at the time.

By 1993, interest rates had dropped closer to 8%, and Congress realized that the 9.5% guaranteed loan was benefiting the banking industry much more than students. So Congress put in place a mechanism to phase out new student loans by removing the subsidy; or so they thought.

Loopholes Still Exist

Since 1993, banks have found innovative ways - loopholes - that allow them to extend the life of these loans indefinitely. In order to phase out the subsidy, the law allowed banks to collect the subsidy as long as there were outstanding bonds against which the student loans were made. Congress expected the banks to "play fair" by paying off the bonds as the student loans were paid off. Instead, banks created loopholes that allowed then to continually refinance these bonds, thereby extending the subsidy indefinitely.

Ending the Student Loan Loophole

So just how much money is flowing to banks because of this student loan loophole? Back in 2004, interest rates on new student loans were now in the 4% range. A government agency reported that an estimated $1 billion in overpayments were made in that year. After hearing this, Congress and the Bush Administration moved in September 2004 to close these loopholes once and for all, by banning the recycling of these loans. Unfortunately, the House of Representatives failed to support that measure and the problem continues.

In May 2005, Senators Kennedy, Murray, Mikulski, Clinton, Dorgan, and Durbin introduced into the Senate the Student Loan Abuse Prevention Act of 2005, which once again attempts to end these outdated subsidies on student loans. That bill was on calendar to be debated, but was never moved to a vote. Interestingly, some of these same Senators are also working on the Student Aid Reward Act. That Bill would increase the number of student loans made directly by the federal government to students; thereby cutting out the private banks altogether.

The Murray Amendment

The Murray amendment was another recent attempt to close the student loan loophole. This amendment aimed at putting an end to this banking subsidy; and placing the money back into the hands of college students.

Ending the Loophole Increases Student Aid

By ending the loophole, the Murray amendment would have helped to add $290 million back into higher education. The amendment would do this by ending the loophole and:

Doubling state grants to $3,000 for nearly 700,000 students.
Doubling the funding for on-campus childcare programs.
Adding $84 million to Supplemental Educational Opportunity Grants, which would add roughly 200,000 new recipients.
Adding over $70 million to the TRIO program, to help 80,000 low income and first generation students.
Increasing the funding of GEAR UP by $25 million, to help more than 100,000 middle income families pay for college.
Increasing the funding of High School Equivalency type programs by $5 million.
Increasing the College Access Migrant Program by $5 million, which would help migrant and farm workers finish high school.

It may not happen tomorrow, but with a little hope and a lot of help from our Congress, the student loan loopholes will get closed. When that happens, the money will be redirected back to our college students, where it belongs.

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