Federal Reserve regulators warned a Senate committee Tuesday that allowing student loan interest rates to double on July 1 could jeopardize the nation’s economy.
Without congressional action, interest rates on federally subsidized Stafford loans will double from 3.4 percent to 6.8 percent Monday — a change that will likely result in borrowers moving from government subsidized loans to private sector loans, said Todd Vermilyea, senior associate director with the Fed’s banking regulation division.
“Post-secondary education is becoming increasingly expensive. With continued increases in student debt, and high levels of unemployment, recent graduates are finding it more difficult to repay their obligations, resulting in elevated delinquency and charge-off rates,” Vermilyea told the Senate Committee on Banking, Housing and Urban Affairs Tuesday.
“Borrowers who are delinquent on student debt may face difficulty obtaining other forms of credit,” Vermilyea said.
In a slow-recovering economy dependent upon young borrowers to purchase cars and homes through credit and mortgages throughout their lifetimes, the rate hike could mean prolonged economic stagnation, he testified.
Outstanding student loan debt almost doubled between 2007 and 2013, going from $550 billion to more than $1 trillion today, and is the second largest source of debt in the country next to home mortgages. Student loans are the only form of borrowing that increased in the wake of the 2008 housing and financial crisis.
Federal student loans make up 85 percent of the nation’s higher-education debt, with the private sector covers 15 percent. Despite Vermilyea’s warning, government-sponsored loans actually make up that largest delinquency rate — 21 percent — while private lenders have a delinquency rate of 4 percent.
Although the government sponsors a much larger amount of student loans — $105 billion in 2012 compared to $8 billion by private banks — other factors influence delinquency, such as eligibility. Private lenders regularly perform credit checks and require co-signers, whereas federal loans often do neither.
“A restructured loan that’s performing is far better for everyone than a severely delinquent loan,” Vermilyea said while speculating what he described as private banks’ less lenient repayment policies. “It’s not clear why this isn’t happening more. Our regulatory policy would certainly permit it and even encourage appropriate workouts.”
Rohit Chopra of the Consumer Financial Protection Bureau testified alongside Vermilyea Tuesday, suggesting that the government use the Fed’s current cheap borrowing policies to help re-finance high interest and cost student loans.
“Borrowers with both federal and private student loans have been frustrated with the inability to refinance fixed-rate loans to take advantage of today’s historically low interest rates and their improved credit profile,” Chopra said according to his prepared statement.
Chopra went on to describe key areas of economic stability that would be affected if action is not taken including home buying and the mortgage market, small business and entrepreneurship, retirement funding, healthcare, and of course — education.