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How Obama's budget affects student loans

(MoneyWatch) In his 2014 budget request to Congress, President Obama is seeking to end the dubious practice of Congress setting student loan interest rates. 

In what could be considered a mixed outcome for college students, Mr. Obama's budget proposes aligning rates on new student loans to more closely follow market rates. The rates would be linked to 10-year U.S. Treasuries.

Currently, Congress sets the interest rates on federal college loans such as the Stafford Loan, which is the nation's most popular student loan. The interest rate on the unsubsidized Stafford Loan is 6.8 percent, and the rate on the subsidized Stafford is 3.4 percent. The latter rate is scheduled to double on July 1, but Obama's budget would stop this hike. According to projections by the Congressional Budget Office, under the president's proposal the unsubsidized rate would not reach 6.8 percent within at least the next 10 years.

Rates on new federal college loans would be based on the 10-year Treasury plus a cushion, depending on the type of loan. According to the CBO, the rates on the unsubsidized Stafford Loans would exceed their current 6.8 percent cap by 2016 and then top 8 percent by 2018 and stay there until 2023. The rates for Stafford borrowers would be fixed for the life of the loan even if interest rates dropped significantly.

Advocacy groups are unlikely to be pleased by such substantial future rate hikes.

Student loans and political football

Loan interest rates have become a political football for one very obvious reason: Congress.

In the months leading up to last year's presidential election, there was friction in Washington over the looming expiration of the lower Stafford rate. Lawmakers ultimately kept the unsubsidized Stafford rate at 3.4 percent for one year. Now the fight over the expiring student loan rate is revving up again as the July 1 deadline for the Stafford hike nears.

What's essential to grasp here is that the unsubsidized Stafford interest rate increase -- if it happens -- will not impact the $1 trillion or so in outstanding student loan debt. It will only affect current students who will borrow via the subsidized Stafford for the 2013-14 school year. Last year, the rate hike would have affected only about 3 percent of student debt.

At the time, Mark Kantrowitz, the publisher of the FinAid.org, estimated that the rate change would require students to pay $761 over a 10-year repayment period. That breaks down to just $1.46 a week.

In better news for borrowers, the president's budget also would expand the valuable Income Based Repayment program, which essentially allows people who are unemployed or underemployed to pay back their federal student loans based on what they can pay rather than what they owe.