Student loans are a great deal - for the government

Congress returns next week, and one of the first things on the agenda will be figuring out how to pay for the cost of keeping interest rates low on federally guaranteed student loans.

Republicans and Democrats now both agree that interest rates on the subsidized loans should remain at 3.4 percent for at least another year, rather than doubling to 6.8 percent in July. But the argument about how to pay for that decision has prompted some degree of soul-searching about what role, if any, the federal government should play in helping finance a college education.

Here's an important question that's not being asked, however: How much of a profit should the federal government be entitled to make on student loans?

Now, the possibility that the federal government actually makes money on student loans may sound wildly improbable. Over the last several months we've heard repeatedly that keeping interest rates at the current level of 3.4 percent will "cost" the federal government $6 billion. Republicans want to pay for the reduced interest rates by trimming spending from health programs. Democrats want to go after tax breaks for businesses.

But the truth is that taxpayers do quite well by the student loan business. If you think about it just a little, it's not hard to figure out why: The U.S. government pays almost nothing to borrow money that it lends out to college students at much higher interest rates. The current interest rate on a subsidized Stafford loan is 3.4 percent; on an unsubsidized Stafford loan the interest rate is 6.8 percent.

True, the default rate on federally guaranteed student loans is higher than the 10 percent typical on most unsecured consumer loans. Then again, student loans are unlike most consumer debts in important ways that benefit the lender, which in this case is the U.S. Treasury.

Many borrowers will take 10 years or longer to repay their loans, and there's little risk of prepayment. Student loan debt can't be discharged in bankruptcy, and it's one of the few consumer debts that can be collected by garnishing someone's tax refund or even their monthly Social Security check. The latter is more likely than you might imagine: Of the total outstanding student loan debt of almost $1 trillion, $36 billion is owed by people 60 and older.

These collection rights are why the federal Department of Education estimates that it will recover as much as 80 percent of defaulted loans. Even though credit losses in the current fiscal year are projected to be about $5 billion, the Congressional Budget Office estimates that the government will book about $37 billion in profits from federally guaranteed student loans this year. Indeed, one of the smartest financial decisions made by the federal government in recent years was to start making the loans directly, rather than paying private lenders to run the program.

True, keeping interest rates low for another year would deprive the Treasury of billions of dollars in additional profits. Budget watchdogs also argue that the lowered interest rates on federal loans were always meant to be temporary. The 2007 measure, which was signed by President George W. Bush, came with an expiration date everybody knew about.

But that argument doesn't hold water when you consider that the Bush tax cuts, which have deprived the Treasury of more than $2 trillion in revenue since 2001, also came with a sunset provision that, if allowed to occur, would halve the deficit. Instead, those tax cuts have been extended.

At a time when college has become both increasingly necessary and expensive, allowing the interest rate on student loans to double means inflicting economic pain at kitchen tables around the country. Here's how that dilemma looks in Minnesota: Twenty years ago, a year's tuition at the University of Minnesota consumed 8 percent of the state household median income. Last year, that figure was 19 percent.

Fairly or not, household incomes have stagnated over the last two decades while college costs galloped ahead at twice the rate of inflation. That forces an increasing number of students and their families to borrow money to make a downpayment on their future.

Paying 6.8 percent on a $4,200 loan repaid over 12 years would mean having to cough up an additional $1,000 in interest. That doesn't sound like a lot until you factor in how much the average student with debt typically borrows. In 2010, it was $22,250 across the United States and more than $29,000 in Minnesota.

There may be legitimate questions and concerns about the cost of a college education, but there's little doubt about the long-term value of that degree. The median annual earnings of a 25- to 34-year-old worker with a bachelor's degree came to $40,875 in 2010, almost 40 percent higher than the national median for all workers in that age group. The unemployment rate for men in that age group was less than 5 percent for those having a bachelor's degree or higher, but 14 percent for those having only a high school diploma.

The question isn't whether taxpayers can afford to keep subsidizing and guaranteeing student loans for next year and beyond. Rather, how can we afford not to?

ericw@startribune.com • 612-673-1736

Eric Wieffering is moving to a new role at the Star Tribune as assistant managing editor for news. This is his final column.