(Bloomberg) Congress gave final approval to legislation that would peg the interest rates on government-sponsored student loans to a market-based rate, ensuring that almost 9 million undergraduates will pay 3.86 percent interest on their next loan.

The Republican-run House voted 392-31 under streamlined procedures requiring a two-thirds supermajority—to accept changes made by the Democratic-controlled Senate to legislation it initially passed in May. That clears the bill, H.R. 1911, for President Barack Obama, who backs the compromise. In his budget proposal this year, Obama called for linking interest rates on Stafford and PLUS loans to the government’s borrowing costs.

Enactment of the legislation will provide certainty to students who rely on government loans and to private lenders such as SLM Corp., popularly known as Sallie Mae, and Wells Fargo & Co.

“Sallie and other private lenders can know where federal loan rates are going to be and therefore plan accordingly,” said Michael Tarkan, who follows private lenders for Washington- based Compass Point Research and Trading. “The competition from the private side will go up against the federal PLUS Loan market.”

Borrowing Costs
The new rates, pegged to the yield on the 10-year Treasury note, will be retroactive to July 1— the day that the interest rate for subsidized Stafford loans doubled from 3.4 percent to 6.8 percent, matching the rate for unsubsidized loans.

The government pays the interest on subsidized loans while students are in school. Those loans are disbursed based on financial need, while unsubsidized loans have no income requirement. Students take out new loans for each academic year.

Senate Democrats had resisted proposals by both House Republicans and Obama to tie rates to fluctuations in the 10-year Treasury yield.

The legislative impasse prevented Congress from averting the previously scheduled July 1 doubling of the interest rate for about 7 million low-income students who take out subsidized Stafford loans.

Republicans had highlighted the division between Obama and Senate Democrats, with House leaders repeatedly calling on the Senate to pass legislation meeting the president’s requirement that interest rates reflect government borrowing costs.

Bipartisan Breakthrough
The breakthrough came on July 18, when a bipartisan group of eight senators agreed to a compromise that the Senate passed, 81-18, on July 24. Republican negotiators led by Tennessee Senator Lamar Alexander, a former U.S. education secretary, agreed to a demand by Democrats that rates for undergraduate loans be capped at 8.25 percent.

Loans to about 1.5 million graduate students who take out Stafford loans will be capped at 9.5 percent. The rate cap for PLUS loans to more than 1 million graduate students and parents of undergraduates is 10.5 percent.

Stafford loans limit the amount that can be borrowed, while PLUS loans have no restrictions.

The Senate’s approval of the bipartisan compromise was praised by House Speaker John Boehner, an Ohio Republican, who called the revised legislation “a victory for students and parents” that is “consistent with the House Republican bill passed in May.” House Minority Leader Nancy Pelosi, a California Democrat, called the Senate vote “a concrete step toward restoring the economic security, educational opportunities, and peace of mind of America’s students.”

Variable Rates
A leading Democratic opponent of variable rates, Rhode Island Senator Jack Reed, argued during Senate debate that the legislation marked a “fundamental shift” in how Congress dealt with student loans. Under the bill, he said, students in college now will benefit from lower interest financed by higher borrowing costs for students who won’t start college for four or five years.

Variable rates pegged to the 91-day Treasury bill were used to determine subsidized Stafford loans when the direct student loan program began operation in 1992. A decade later, legislation was enacted to begin a four-year transition to a fixed rate of 6.8 percent for Stafford loans starting July 1, 2006.

In 2007, Congress incrementally reduced the interest rate to 3.4 percent for subsidized Stafford loans. That rate was to expire on July 1, 2012, and jump to 6.8 percent. Responding to Obama’s election-year call to keep borrowing costs low for financially needy students—an appeal endorsed by Obama’s Republican opponent in the presidential campaign, Mitt Romney—Congress extended the 3.4 percent rate for another year.

Pressure on Lawmakers
The July 1 doubling of that rate meant that all Stafford loans, subsidized and unsubsidized, were set at a fixed rate of 6.8 percent. The increase put pressure on lawmakers to act before Congress begins its five-week summer recess at the end of this week so that students returning to college next month will not have to pay the higher rates.

House Republicans today took credit for taking timely action and blamed Senate Democrats for the delay.

“The House acted early, long before the deadline,” Majority Whip Kevin McCarthy of California told reporters. “The Senate went through a lot of different movements,” he said. Congress should “never have to go past that deadline.”

Under the legislation passed today, the interest rate for all undergraduate Stafford borrowers will be 2.05 percentage points higher than the yield on the 10-year Treasury note at the last auction before June 1.

That yield was 1.81 percent at the May 15 auction, the last one the Treasury Department conducted before June 1. That puts the rate for undergraduate Stafford loans for the 2013-2014 academic year at 3.86 percent.

Other Rates
Graduate Stafford loans will be set at 3.6 percentage points more than the 10-year Treasury yield, or 5.41 percent for the coming school year.

PLUS loans will be marked up 4.6 percentage points above the 10-year Treasury yield, for an interest rate of 6.41 percent in the coming year.

Unlike the original House measure, students can lock in an interest rate each year that they borrow money. The House plan would have required students to pay a varying interest rate on the rolling total of what they borrow to finance higher education, with an 8.5 percent cap.

“Like the 30-year mortgage, once you take out the loan, you know what your rate is going to be so you can plan on it,” House Minority Whip Steny Hoyer, a Maryland Democrat, told reporters yesterday. He called the measure “a compromise to the extent it reflects market rates’’ sought by Republicans and Obama.

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