This post considers the potential reduction in interest
costs stemming from the elimination of student loans for firstyear
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
firstyear students at fouryear public universities.
The elimination of firstyear debt requires additional
resources in the form of grants and workstudy funds. This post is part of the explanation of why
the applications of additional resources towards firstyear students is a more
cost effective strategy than the application of additional resources towards
the entire population of college students.
Background: A dependent firstyear 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 nonguaranteed student loan.
The government pays all interest on the guaranteed student
loan until repayment begins. The
student is responsible for all interest payments on nonguaranteed student
loans; however, fulltime 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 nonguaranteed 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 fulltime student for four academic years and takes advantage of a
sixmonth grace period after leaving fulltime status?
What are the interest costs on these loans if the person
remains a fulltime student for six years and takes advantage of the sixmonth
grace period?
Discuss the implications of this analysis for my proposal to
eliminate college debt for firstyear 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
nonguaranteed 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 nonguaranteed student debt for a
firstyear students until repayment begins.
Calculations are presented for a person who remains a fulltime student
for four years and for six years at both the 5.0% and 7.0% interest rates.
FourYear Results:
At a 5.0% interest rate interest costs are $361 for
guaranteed loan and $20 for nonguaranteed loan.
At 7.0% interest rate interest costs are $511 for guaranteed
loan and $292 for nonguaranteed loan.
SixYear Graduation
Results:
Interest costs are approximately 34% higher for the person
who takes 6 years to graduate.
Interest Costs on FirstYear
Student Debt


Loan Repayment Begins 49
Months After First Loan is Received


Guaranteed Student Loan

NonGuaranteed Student
Loan

Guaranteed Student Loan

NonGuaranteed 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

NonGuaranteed Student
Loan

Guaranteed Student Loan

NonGuaranteed 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 firstyear 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 nonguaranteed loans. A
financial aid reform effort that targets debt incurred by firstyear 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 firstyear 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.
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.
No comments:
Post a Comment