November 13, 2013

Mandatory SpendingOption 6

Function 500 - Education, Training, Employment, and Social Services

Reduce or Eliminate Subsidized Loans for Undergraduate Students

(Billions of dollars) 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2014-2018 2014-2023
Change in Outlays                        
  Restrict access to subsidized loans to students eligible for Pell grants -0.5 -1.3 -1.7 -1.9 -1.9 -2.0 -2.0 -2.1 -2.1 -2.2 -7.3 -17.7
  Eliminate subsidized loans altogether -1.1 -3.0 -4.0 -4.3 -4.5 -4.7 -4.8 -4.9 -5.0 -5.1 -16.9 -41.4

Note: This option would take effect in July 2014.

The Federal Direct Student Loan Program lends money directly to students and their parents to help finance postsecondary education. Three types of loans are offered: subsidized loans and unsubsidized loans (which take their names not as an indication of the rates provided but because of other terms of the loans) and PLUS loans. Subsidized loans do not accrue interest while students are enrolled at least half-time, for six months after they leave school or drop below half-time status, and during certain other periods when borrowers may defer making payments; those loans are available only to undergraduates with demonstrated financial need.

Unsubsidized loans accrue interest from the date of disbursement; they are available to students regardless of need. PLUS loans also accrue interest beginning at disbursement; they are available to parents of dependent students and to graduate students. The program’s rules cap the amount that students may borrow through subsidized and unsubsidized loans, with both annual limits and lifetime limits; no such cap applies for PLUS loans.

This option includes two possible changes to subsidized loans, which, by the Congressional Budget Office’s estimates, will constitute about half of the dollar volume of federal direct loans to undergraduate students for the 2013–2014 academic year. In the first alternative, access to subsidized loans (and the associated interest subsidies) would be restricted to students eligible for Pell grants. The Federal Pell Grant Program provides grants to help finance postsecondary undergraduate education; to be eligible for those grants, students and their families must demonstrate financial need. Under current law, fewer students are eligible for Pell grants than are eligible for subsidized loans, so this change would reduce the number of students who could take out subsidized loans. Specifically, CBO projects that about 45 percent of students who would borrow through subsidized loans under current law would lose their eligibility for those loans—and would instead borrow almost as much through unsubsidized loans. As a result, federal costs would be reduced by $18 billion from 2014 to 2023, CBO estimates.

In the second alternative, subsidized loans would be eliminated altogether. In this case, CBO also expects that students would borrow almost as much through unsubsidized loans as they would have borrowed through subsidized loans, and federal costs would be reduced by $41 billion from 2014 to 2023.

Under either alternative, borrowers who lost access to subsidized loans would pay interest on unsubsidized loans from the date of loan disbursement, which would raise their costs. If a student who would have borrowed $23,000 (the lifetime limit) through subsidized loans over five years beginning with the 2014–2015 academic year instead borrowed the same amount through unsubsidized loans, that student would leave school with additional debt of about $3,800 because of the accrued interest costs. Over a typical 10-year repayment period, the student’s monthly payment would be $43 higher than if he or she had borrowed that same amount through subsidized loans.

Perspectives on those higher borrowing costs vary. According to an argument in favor of this option, postsecondary educational institutions might respond to increases in costs faced by their students by slowing tuition increases. If institutions responded in that way, then the effect of higher borrowing costs would be offset at least partially by lower tuition than would otherwise be charged. Also, higher costs might encourage students to pay closer attention to the economic value to be obtained from a degree, particularly in the form of increased earnings, and to increase the speed with which they complete a postsecondary program.

But by an argument against this option, students faced with a higher cost of borrowing for education might cut back on spending for education, by, for example, deciding not to attend college, leaving college before completing a degree, or applying to schools with lower tuition but educational opportunities not as well aligned with their interests and skills. Those decisions eventually could lead to lower earnings. Moreover, for any given amount borrowed, raising interest costs would require borrowers to devote a larger amount of their future income to interest payments. That, in turn, could strain their ability to make other financial commitments, such as buying a home.