Order Code RS22568
Updated January 30, 2007
Stafford Loan Interest Rate Reduction:
Background and Issues
David P. Smole
Specialist in Social Legislation
Domestic Social Policy Division
Summary
Subsidized and unsubsidized Stafford Loans are the primary sources of federal loan
aid available to assist students finance the costs of a postsecondary education. These
loans are made available under both the Federal Family Education Loan (FFEL)
program and the William D. Ford Direct Loan (DL) program. Through these programs,
students may borrow loans with terms and conditions that are generally more favorable
than loans from private lenders. Effective July 1, 2006, the interest rate on new Stafford
Loans is fixed at 6.8%. For loans made on or after October 1, 1992, and prior to July
1, 2006, interest rates are variable and adjust annually. H.R. 5, as passed by the House,
would reduce interest rates on subsidized Stafford Loans that are disbursed to
undergraduate students from July 1, 2007, to December 31, 2011. This report provides
a brief overview of selected terms and conditions of Stafford Loans, characteristics of
borrowers, and a description of how reduced rates proposed under H.R. 5 would
compare with current terms and conditions.
Introduction
The increasing desirability of obtaining a postsecondary education, rising college
prices, and concerns about financing college costs have increased the visibility of federal
student aid programs. Of particular concern is the amount students borrow for college
and their resulting debt burden. Also, recently implemented changes to the FFEL and DL
programs have resulted in a new interest rate structure for Stafford Loans with loans
disbursed on or after July 1, 2006, carrying a fixed interest rate of 6.8%; whereas in prior
years, loans were disbursed with variable, annually adjusting interest rates. In the early
part of this decade, interest rates had dropped to historic lows, but recently have risen to
levels more consistent with historic norms. The combination of recent interest rate
changes, rising college prices, and concerns about student loan debt burden have put
student loans on the agenda of the 110th Congress.
In the 110th Congress, proposals are being considered to reduce interest rates on
student loans to make them less costly to borrowers. On January 17, 2007, the House
passed H.R. 5, which would incrementally reduce interest rates on subsidized Stafford

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Loans for undergraduate students over a five-year period beginning with academic year
(AY) 2007-2008. Under H.R. 5, interest rates would be reduced from the current fixed
rate of 6.8% to 6.12% for loans disbursed in AY2007-2008; 5.44% for loans disbursed
in AY2008-2009; 4.76% for loans disbursed in AY2009-2010; 4.08% for loans disbursed
in AY2010-2011; and 3.4% for loans disbursed in the first half of AY2011-2012 (through
December 31, 2011). Rates would then revert back to 6.8% for loans disbursed
subsequently, unless the rate reduction was extended through other legislation. Among
other things, H.R. 5 would also decrease the special allowance rate (SAP) for larger
lenders by 10 basis points (0.10%) and increase loan fees paid by lenders.
FFEL and DL Stafford Loans
Subsidized and unsubsidized Stafford Loans are made to undergraduate and graduate
students under both the FFEL and DL programs.1 Under the FFEL program, loans are
made by approximately 3,600 banks and other eligible lenders to students in attendance
at more than 5,000 institutions of higher education (IHEs). Loan capital for FFEL
program loans is provided by private lenders and the loans are guaranteed by the federal
government against loss due to borrower default. State and nonprofit guaranty agencies
administer the federal loan guarantee. To help ensure that private capital will consistently
be available for lending under the FFEL program, the federal government provides certain
incentives to lenders, most notably the SAP. The SAP is a market-indexed loan subsidy
payment made by the federal government to compensate lenders for the difference
between statutorily established borrower interest rates and a market rate of return.2
Under the DL program, the federal government provides loans directly to students
using federal capital (i.e., funds from the U.S. Treasury), and owns the loans. DL
program loans are originated either by the institution a student attends or by a contractor
of the U.S. Department of Education (ED). Loan servicing (i.e., billing borrowers,
collecting payments, collecting on defaulted loans) is done by ED contractors.
Approximately 1,100 institutions participate in the DL program. The DL program was
initially intended to replace the FFEL program, but now both programs operate alongside
one another. Each institution chooses whether to participate in the FFEL or DL program.
Subsidized and Unsubsidized Stafford Loans. There are two types of
Stafford Loans — subsidized and unsubsidized. Currently, the same interest rate applies
to both types of loans — 6.8% for loans disbursed on or after July, 1, 2006. Subsidized
Stafford Loans
are available to undergraduate and graduate students to help them finance
their postsecondary education expenses. The federal government “subsidizes” these loans
by paying the interest that accrues while the student is enrolled in school on at least a
half-time basis, and during grace and deferment periods. Students must establish financial
need to qualify for subsidized Stafford Loans. Unsubsidized Stafford Loans are also
available to both undergraduate and graduate students. The major distinctions between
1 For additional information on the FFEL and DL programs, see CRS Report RL33673, Federal
Family Education Loan Program and William D. Ford Direct Loan Program Student Loans:
Terms and Conditions for Borrowers
, by Adam Stoll. (Hereafter, CRS Report RL33673).
2 For a discussion of the SAP and other aspects of the administration of these loan programs, see
CRS Report RL33674, The Administration of the Federal Family Education Loan and William
D. Ford Direct Loan Programs: Background and Provisions
, by Adam Stoll.

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the two types of loans are that for unsubsidized Stafford Loans, the federal government
does not pay the interest that accrues while the borrower is in school or during deferment
and grace periods; and students may qualify for unsubsidized Stafford Loans irrespective
of their expected family contribution (EFC) (i.e., they are not need-based).3
Interest Rates. Both subsidized and unsubsidized Stafford Loans carry the same
interest rate. For loans disbursed on or after July 1, 2006, the interest rate is fixed at
6.8%. For loans disbursed between October 1, 1992, and June 30, 2006, the interest rate
is variable and adjusts annually. The formula used to calculate the variable interest rate
for those loans is determined by statute and stays in effect from the time the loan is
disbursed through the life of the loan, or until the loan is consolidated. The variable rate
is calculated based upon the bond equivalent rate of the 91-day Treasury bill, plus a
premium which differs depending on when the loan was disbursed; and whether the
borrower is in school, a grace period, or deferment, or is in repayment. The interest rate
on variable rate loans adjusts each year on July 1. Prior to October 1, 1992, Stafford
Loans carried fixed interest rates. Table 1 presents a history of interest rates in effect
during repayment on Stafford Loans disbursed on or after October 1, 1992.4
Table 1. Stafford Loan Interest Rates in Effect During Repayment:
1992-1993 through 2006-2007
Disbursement Period
Date
Oct. 1, 1992 to July 1, 1994 to July 1, 1995 to July 1, 1998 to On or after
June 30, 1994 June 30, 1995 June 30, 1998 June 30, 2006
July 1, 2006
1992-1993
6.94
1993-1994
6.22
1994-1995
7.43
7.43
1995-1996
8.92
8.25
8.25
1996-1997
8.26
8.25
8.25
1997-1998
8.26
8.25
8.25
1998-1999
8.26
8.25
8.25
7.46
1999-2000
7.72
7.72
7.72
6.92
2000-2001
8.99
8.25
8.25
8.19
2001-2002
6.79
6.79
6.79
5.99
2002-2003
4.86
4.86
4.86
4.06
2003-2004
4.22
4.22
4.22
3.42
2004-2005
4.17
4.17
4.17
3.37
2005-2006
6.10
6.10
6.10
5.30
2006-2007
7.94
7.94
7.94
7.14
6.80
Sources: U.S. Dept. of Education, Office of Federal Student Aid, FFEL Variable Interest Rates; and CRS
Report RL32424, Consolidation Loans: Redesign Options and Considerations, by Adam Stoll.
3 For a thorough discussion of subsidized and unsubsidized Stafford Loans, see CRS Report
RL33673.
4 Lower interest rates apply during in-school, grace, and deferment periods; however, since for
subsidized Stafford Loans, this interest is paid by the federal government during these periods,
these rates are not shown. Lenders also may make loans at lower interest rates or reduce rates
for timely repayment.

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H.R. 5 would reduce interest rates only for undergraduate borrowers of subsidized
Stafford Loans. The interest rate on unsubsidized Stafford Loans and on subsidized
Stafford Loans borrowed by graduate students would remain at 6.8%. As shown in Table
1
, for loans disbursed on or after October 1, 1992, interest rates during repayment on
Stafford Loans have been at or lower than 3.4% only during the period from July 1, 2004,
to June 30, 2005, and only for loans that had been disbursed on or after July 1, 1998. For
most of the history of the Stafford Loan program, interest rates on variable rate loans have
been at or above 6.79% during repayment.5 (For purposes of comparison, under the
Federal Perkins Loan program — the other major subsidized student loan program — all
loans disbursed on or after October 1, 1981, carry a fixed interest rate of 5.0%.) The
proposed interest rate reduction would result in increased costs to the government under
the FFEL program due to larger SAP payments to lenders; and under the DL program due
to receipt of reduced revenue from interest payments.6
Loan Volume and Characteristics of Borrowers
Loan Volume. Borrowing under the subsidized and unsubsidized Stafford Loan
programs constitutes the largest single source of direct federal student aid to help students
finance their postsecondary education expenses. In academic year FY2006, more than
$36 billion in subsidized and unsubsidized Stafford Loan aid was made available to
undergraduate students under the FFEL and DL loan programs. The number of
undergraduate borrowers and committed loan volume for FY2006 is presented in Table
2
for both programs.
Table 2. FFEL and DL Undergraduate Borrowers
and Committed Loan Volume: FY2006
FFEL
FFEL Loan
DL
DL Loan
Total Loan
Loan Type
Borrowers
Volume
Borrowers
Volume
Volume
Subsidized
4,394,000 $15,537,000,000 1,148,000 $4,113,000,000 $19,650,000,000
Unsubsidized
3,345,000 $13,505,000,000
778,000 $2,949,000,000 $16,454,000,000
Source: U.S. Dept. of Education, Office of Postsecondary Education, National Student Loan Data System.
Income Distribution of Borrowers. Data on the distribution of undergraduate
Stafford Loan borrowers in AY2003-2004, by 2002 income percentiles are presented in
Table 3. The table shows total 2002 income for the parents of dependent students and
for independent students and their spouses at selected percentile point breaks. For
instance, column B shows incomes for various categories of students at the 25th percentile
(i.e., 25% of students have lower incomes); and column C shows median incomes.
5 However, interest rates have also been lower on federal student loans. For example, Guaranteed
Student Loans (GSLs) were originally made at a fixed interest rate of 6%; and borrowers whose
income was below a certain threshold at the time of disbursement were eligible to have 3
percentage points of their interest paid by the federal government (P.L. 89-329, § 428(a)(2)).
6 An examination of the cost to the government of this proposal, and issues such as its effect on
student access to and persistence in postsecondary education are beyond the scope of this report.

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Table 3. Income Percentile Distribution
of Undergraduate Stafford Loan Borrowers: AY2003-2004
10th
25th
50th
75th
90th
percentile
percentile
percentile
percentile
percentile
(A)
(B)
(C)
(D)
(E)
Dependent
All students
$16,305
$32,370
$59,443
$91,754
$130,485
Stafford borrowers total
$17,519
$31,842
$55,827
$85,540
$117,266
Subsidized Stafford
$14,553
$26,353
$44,681
$67,373
$91,468
Unsubsidized Stafford
$24,862
$45,885
$75,837
$104,201
$141,376
Independent
All students
$3,500
$11,214
$25,415
$49,415
$77,031
Stafford borrowers total
$3,519
$9,355
$20,052
$35,394
$57,533
Subsidized Stafford
$3,335
$8,924
$19,034
$32,272
$51,228
Unsubsidized Stafford
$4,000
$10,272
$21,483
$37,855
$61,020
Source: U.S. Dept. of Education, National Postsecondary Student Aid Study, 2004 (NPSAS:2004); CRS
calculations.
Notes: Income data are 2002 total income. Data on borrowers of subsidized Stafford Loans and
unsubsidized Stafford Loans are not mutually exclusive. Since students qualify for subsidized Stafford
Loans on the basis of need, it is not uncommon for students whose subsidized Stafford Loan amounts are
less than the statutory maximum to borrow the difference between their subsidized Stafford Loan eligibility
amount and the statutory maximum through unsubsidized Stafford Loans. Thus, many students borrow both
types of loans.
Both dependent and independent Stafford Loan borrowers are distributed across a
slightly lower income range than undergraduate students overall. However, for dependent
students, there is considerable variation between the income distribution of borrowers of
subsidized Stafford Loans and borrowers of unsubsidized Stafford Loans. Dependent
student borrowers of subsidized Stafford Loans had a median 2002 income of $44,681,
compared with a median income of $75,837 for borrowers of unsubsidized Stafford
Loans. There was less variation among undergraduate independent borrowers, with the
median income of borrowers of subsidized Stafford Loans being $19,034, compared with
$21,483 for borrowers of unsubsidized Stafford Loans.
Subsidized Stafford Loan Borrowing. During AY2003-2004, 27.7% of
undergraduate students borrowed subsidized Stafford Loans, and these students borrowed
an average amount of $3,232.7 Borrowers who graduated that year, had borrowed an
average cumulative amount of $10,842 in subsidized Stafford Loans.8 Loan limits on
Stafford Loans vary by class level, with annual loan limits rising as students progress
through college. The amount students actually borrow also tends to increase as they
become eligible for larger loan amounts. Table 4 presents information on current loan
limits for subsidized Stafford Loans and average amounts borrowed by undergraduate
students during AY2003-2004.
7 U.S. Dept. of Education, NPSAS:2004; CRS calculations.
8 Ibid.

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Table 4. Subsidized Stafford Loan Limits and Average Borrowing
by Undergraduate Students: AY2003-2004
Statutory Loan Limits
Borrowing by class level
Percent who
Average amount
Class Level
Loan Limit
Class Level
borrowed
borrowed
1st year
$2,625
1st year
27.4
$2,190
2nd year
$3,500
2nd year
24.4
$2,932
3rd year and
$5,500
3rd year
37.8
$4,360
beyond
4th year
35.8
$4,288
5th year
32.3
$4,138
Sources: HEA, § 428(b)(1)(A); U.S. Dept. of Education, NPSAS:2004; CRS calculations.
Interest Amortization. The amount of interest a borrower pays over the life of
a subsidized Stafford Loan is a function of the amount borrowed, the interest rate, and the
duration of the repayment period. Reduced interest rates on subsidized Stafford Loans
could substantially affect the amount of interest borrowers pay over the life of their loans.
Table 5 presents case simulations of two types of borrowers under current law and H.R.
5. Case A is a borrower who first enrolls in AY2007-2008 and over five years borrows
$2,000 in year 1; $3,000 in year 2; and $4,000 in each of years 3 through 5. Case B is a
borrower who begins enrollment in AY2008-2009 and over four years borrows $2,000
in year 1; $3,000 in year 2; and $4,000 in each of years 3 and 4. Both borrowers
consolidate their loans and select a standard 10-year repayment period. (For loans of these
amounts, unless consolidated, fixed interest rates below 6.8% would result in less total
interest paid over a shorter repayment period, but no decrease in monthly payments due
to the required minimum monthly payment of $50 under the standard repayment plan.)

Table 5. Case Simulations of Monthly Payments and Total Interest
on Subsidized Stafford Loans: Current Law and H.R. 5
Cumulative
Consolidation
Monthly
Total
Total
Case
borrowed
rate
payment
interest
repayment
Borrower A
Current law
$17,000
6.875
$196.29
$6,555
$23,555
H.R. 5
$17,000
4.625
$177.21
$4,265
$21,265
Savings
$19.08
$2,290
$2,290
Borrower B
Current law
$13,000
6.875
$150.10
$5,012
$18,012
H.R. 5
$13,000
4.250
$133.17
$2,980
$15,980
Savings
$16.93
$2,032
$2,032

Source: CRS calculations using U.S. Dept. of Education, Office of Federal Student Aid interest calculator.
Notes: The interest rate for a Consolidation Loan is the weighted average of the interest rates on the loans
being consolidated, rounded to the nearest higher one-eighth of one percent.
Table 5 shows that compared with current law, under H.R. 5, Borrower A would
save $2,290 in total interest over a 10-year repayment period, while Borrower B would
save $2,032. However, each would have his or her monthly payments reduced by less
than $20. Under H.R. 5, Borrower A would pay 34.9% less in total interest over the
duration of the loan, and would pay 9.7% less per month and in total payments. Borrower
B would pay 40.5% less in total interest, and 11.3% less overall.