Lenders’ fears could raise interest on student loans

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As if rising tuition costs weren’t enough, many college students could soon face higher interest rates on their student loans, another potential aftershock of last week’s U.S. credit downgrade by Standard & Poor’s.

Federal lending such as the popular Stafford loan program will be unaffected because the interest rates are fixed at 3.4 percent. But private loans from banks usually come with variable rates, making them vulnerable to volatility in the stock market and lenders’ fears that, with the economy still in turmoil and jobs in short supply, students will be unable to repay their debts.

Coupled with cuts for education in many state budgets and subsequent increases in tuition by major universities, a 1- or 2-point rise in interest rates could be the final straw for some students, said Mark Kantrowitz, a financial aid specialist and publisher of finaid.org.

“It’s another nail in the coffin,” he said.

About 14 percent of the nation’s undergraduates take out private loans, according to the 2007-2008 National Postsecondary Student Aid Study, a survey conducted every four years by the Education Department. Students turn to private lenders if they aren’t eligible for federal grants or loans, which are awarded based on financial need.

Even students who qualify for federal help may be attracted to private loans because, at their lowest interest rates, they may be a better bargain than government lending.

For example, JPMorgan Chase & Co., one of the largest banks in the nation, offers private loans through its ChaseSelect program with a variable interest rate of 3.25 percent to 9.5 percent, but the institution bluntly tells students on its website that “any [interest rate] increase will result in either a higher payment amount or more payments by extending” the term of the loan.

Students who turn to private loans should know the risk that economic factors - such as the credit downgrade - will directly affect them, said Heather Jarvis, a financial aid analyst and chairwoman of the American Bar Association’s Committee on Government Relations and Student Financial Aid.

“When getting money is more expensive for banks, they’re going to pass that on to consumers,” she said.

The potential impact on interest rates will be blunted by the fact that Moody’s Investor Services and Fitch Ratings, the other two major ratings agencies, have kept the U.S. at AAA status. If they were to follow S&P’s lead, the rise in interest rates will be even more severe, Mr. Kantrowitz said.

If student-loan interest rates rise, it will be the latest in a series of blows to college affordability in the U.S. As part of the continuing budget resolution passed earlier this year, lawmakers cut a provision that allowed some students to receive two Pell Grants in a calendar year.

Buried in the debt-ceiling deal passed last week was the elimination of subsidized Stafford loans for graduate students, meaning the federal government will no longer cover the interest accrued during school.

Without action by Congress, the 3.4 percent fixed interest rate for federal lending will expire at the end of the 2011-2012 academic year and will rise to 6.8 percent next fall, deepening the financial hole college graduates find themselves in.

The average debt burden after college is already about $25,000, Mrs. Jarvis said, and it shows no signs of slowing down.

In a recent report, Moody’s warned that the collective debt of the nation’s college students and graduates will hold the economy back and could produce a generation which owes so much they’re unable to buy homes, new cars or otherwise participate in the economy.

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