Tuesday, March 15, 2016

Interest Costs From Student Loans Taken out by First-Year Students

Interest Costs From Student Loans Taken out by First-Year Students


This post considers the potential reduction in interest costs stemming from the elimination of student loans for first-year students.   The post is relevant for people who are planning the financing of their college education and for policy makers who are considering student financial aid reform proposals.

In a previous post, I put forward a student financial aid reform proposal that called for the elimination of the use of student loans by first-year students at four-year public universities.



The elimination of first-year debt requires additional resources in the form of grants and work-study funds.   This post is part of the explanation of why the applications of additional resources towards first-year students is a more cost effective strategy than the application of additional resources towards the entire population of college students.

Background:   A dependent first-year college student can take out $5,500 in student loans during his first year of college.   Of this amount,  $3,500 can be in the form of a guaranteed student loan and $2,000 can be in the form of a non-guaranteed student loan.

The government pays all interest on the guaranteed student loan until repayment begins.   The student is responsible for all interest payments on non-guaranteed student loans; however, full-time students can and usually do capitalize unpaid interest.   The student is required to make all payments six months after no longer being a full time college student.

Question:  Consider a student who borrows $5,500 in his freshman year with $3,500 in the form of a guaranteed student loan and $2,000 in the form of a non-guaranteed loan.   The loan is taken out on the first day of schools.   The interest rate on the loan is either 5.0% or 7.0%/

What are the interest costs on these loans if the person remains a full-time student for four academic years and takes advantage of a six-month grace period after leaving full-time status?

What are the interest costs on these loans if the person remains a full-time student for six years and takes advantage of the six-month grace period?



Discuss the implications of this analysis for my proposal to eliminate college debt for first-year college students.


Analysis:   Remember interest is earned on the student loan as soon as it is issued.   Interest on guaranteed student loans prior to repayment is paid by the government and is a cost of the taxpayer.  Interest on non-guaranteed student loans is the responsibility of the student.  Often the student chooses to capitalize the interest payments when he or she remains a full time student.

The chart below presents interests payments on a $3,500 guaranteed student loan and a $2,000 non-guaranteed student debt for a first-year students until repayment begins.   Calculations are presented for a person who remains a full-time student for four years and for six years at both the 5.0% and 7.0% interest rates.

Four-Year Results:

At a 5.0% interest rate interest costs are $361 for guaranteed loan and $20 for non-guaranteed loan.

At 7.0% interest rate interest costs are $511 for guaranteed loan and $292 for non-guaranteed loan.

Six-Year Graduation Results:

Interest costs are approximately 34% higher for the person who takes 6 years to graduate.



Interest Costs on First-Year Student Debt
Loan Repayment Begins 49 Months After First Loan is Received
Guaranteed Student Loan
Non-Guaranteed Student Loan
Guaranteed Student Loan
Non-Guaranteed Student Loan
Loan Amount
$3,500
$2,000
$3,500
$2,000
Interest Rate
0.05
0.05
0.07
0.07
Date Loan is taken out
9/1/16
9/1/16
9/1/16
9/1/16
Date Repayment Begins
10/1/20
10/1/20
10/1/20
10/1/20
Months
49
49
49
49
Interest during Under graduate Years
-$361
-$206
-$511
-$292
Loan Repayment Begins 73 Months After First Loan is Received
Guaranteed Student Loan
Non-Guaranteed Student Loan
Guaranteed Student Loan
Non-Guaranteed Student Loan
Loan Amount
$3,500
$2,000
$3,500
$2,000
Interest Rate
0.05
0.05
0.07
0.07
Date Loan is taken out
9/1/16
9/1/16
9/1/16
9/1/16
Date Repayment Begins
10/1/22
10/1/22
10/1/22
10/1/22
Months
73
73
73
73
Interest during Under
graduate Years
-$483
-$276
-$685
-$392



Implications:   One reason why the elimination of college debt for first-year students is a relatively cost effective way to reduce the cost of college is that someone must continue to repay interest costs while the student remains in school.   The interest payments prior to the repayment of the student loan are the responsibility of the government for guaranteed student loans and are the responsibility of the student for non-guaranteed loans.   A financial aid reform effort that targets debt incurred by first-year students has a larger impact on interest costs (incurred by the government and by students) than a financial aid reform package that targets all students in college.

The higher default rate of first-year students who are more likely to complete their program is another motivation of a policy proposal geared towards the reduction of college debt at the beginning of a

Authors Note:  The republicans believe in charter school expansion, a program that I viewed as a panacea.   The Democrats believe in free college, an approach that I consider fiscally feasible.

I have been working on a wide range of education policy issues designed to both improve educational outcomes and reduce the cost of college.   The current policy list can be found on the following page.





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