If you’ve been following the news over the past few weeks, you know that Congress and the President have been locked in a bitter debate about the nation’s debt ceiling. The debate boils down to this: the U.S. government spends more money that it receives in revenue, and has been doing so since the country had a surplus in the late 1990’s (government spending particularly skyrocketed following the beginning of the wars in Afghanistan and Iraq in the early 2000’s). We’re about to hit the upper limit of what the U.S. government can borrow under Congressional authorization; in other words, we’re about to “max out” the country’s credit card. If the debt limit isn’t raised by August 2, 2011, and we max out this national credit card, the government will not be able to meet all of its financial obligations. Economists warn this could have a serious impact on the national and global economy. A divided Congress and the President have been negotiating for weeks, trying to reach a deal to avoid a national default. Both sides propose massive spending cuts, but there has been impasse over how high to raise the debt limit, and whether there should also be a corresponding revenue increase by raising taxes on the wealthy. As of today, there are few signs that a deal is near.
So what happens if our government cannot come up with a solution by August 2? Everyone is talking about dire economic consequences, but few are talking about specifics. Here are some potential consequences for student loan borrowers:
Higher Interest Rates. There is very little debate that a national default would raise interest rates. This is because if the U.S. reaches its debt limit, it cannot borrow enough money to meet its financial obligations, so the cost of borrowing goes up across the board. This would directly impact student loan borrowers. For current students, this means that new student loans would have higher interest rates, leading to higher monthly payments later during the repayment period. For former students who are currently paying off their loans, this means that any student loans with “variable” interest rates (interest rates that change periodically) will see an interest rate increase as well. This is particularly true for many private student loans. Higher interest rates may mean higher monthly payments, a longer repayment period, or both.
Reduced Financial Aid. As I’ve said, if the nation does not raise its debt ceiling, the government cannot borrow enough money to meet its financial obligations. This doesn’t mean the government completely shuts down; it means that the government is going to have to prioritize its payments. We do not know at this point how the government will prioritize who gets paid and who does not, but we can assume that certain expenses will certainly have priority over others: defense spending, military salaries, and social security payments to the elderly and the disabled. Beyond that, we really do not know. But student financial aid in the form of grants and low-interest loans may not be high on the priority list, and if that’s the case, current students may face tough decisions about how to pay for school in the coming months.
Reduced Interest Subsidies. One of the great things about many federal student loans (such as Perkins loans and some Stafford loans) is that the government pays the interest while you’re in school. These are known as “subsidized” loans, and it reduces the total cost of your loan while providing an incentive to staying in school. Subsidized loans have been the cornerstone of federal financial aid for decades. If the government cannot meet its financial obligations, however, and has to prioritize its payments, we just do not know where student loan interest subsidies will fall in a priority list. If the government cannot continue to subsidize federal loans, we don’t know who pays the interest– but if it falls on the backs of student borrowers, that means higher payments.
Winston Churchill once said, “The Americans always do what is right… after they’ve exhausted all the alternatives.” The deadline for national default is looming, so let’s hope Winston was right.