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Student Loan Loophole

Last updated 4th Oct 2022

Back in 2005, the Wall Street Journal and the Washington Post reported Congress was going to once again try to close a student loan loophole that's existed since the 1980s.

Anyone old enough to remember the 1980s will recall the double digit interest rates that existed back then. Banks were offering 6-month Certificates of Deposit that yielded over 18%. Interest rates were high, and that made borrowing expensive, especially for students that needed money to pay for college.

Student Loan Interest Rates

At that time, Congress passed a law encouraging banking institutions to lower interest rates on student loans to 9.5% in exchange for guarantees against default on the loan.

By 1993, interest rates had dropped closer to 8.0%, and Congress realized the 9.5% guaranteed loan was benefiting the banking industry 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 it 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 continually refinanced the bonds, thereby extending the subsidy indefinitely.

Ending the Loophole

Back in 2004, interest rates on new student loans were in the 4.0% 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; banning the recycling of these loans. Unfortunately, the House of Representatives failed to support the measure and the problem continued.

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and Durbin introduced into the Senate the Student Loan Abuse Prevention Act of 2005, which once again attempts to end outdated subsidies. 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 loans made directly by the federal government to students; thereby cutting out the private banks altogether. Subsidy Amendments

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

Increasing Student Aid

The Murray amendment would have helped to add $290 million back into higher education by:

  • 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.

About the Author - Student Loan Loophole

Moneyzine Editor

Moneyzine Editor