(Bloomberg) About 11 million U.S. students who need to borrow to cover their college costs would pay 3.86 percent on their next loans under legislation now headed for final passage by Congress.

The Senate voted 81-18 Wednesday to replace fixed interest rates on federal loans with variable rates that will rise or fall annually according to the yield on 10-year Treasury notes.

“This is a victory for students,” said Tennessee Senator Lamar Alexander, a former education secretary who was the lead Republican negotiator. “It makes loans cheaper, simpler, fairer, more certain.”

Members of both parties have been eager to get legislation to the White House for President Barack Obama to sign before the Education Department processes the loan requests of students heading back to college. Negotiating the changes has taken months, in part because of Democrats who wanted to keep the low fixed rate of 3.4 percent that expired July 1.

“This is the best deal we could get for students at this time,” said Senator Tom Harkin of Iowa, who, like many Senate Democrats, resisted pegging borrowing costs to market rates—first proposed by Obama. “It is going to lower interest rates this year and for undergraduate students for the next four years.”

Candidate Pressure
Last year, Congress extended the fixed rate of 3.4 percent for subsidized Stafford loans after Obama made it an issue in his re-election campaign. Obama’s Republican challenger Mitt Romney also endorsed the extension, forcing the Republican-run House to go along with the president and Democrats.

Once that temporary rate expired, the interest for subsidized Stafford loans, which are for lower-income students, increased to 6.8 percent. Unsubsidized Staffords, available at all income levels, had already been at a fixed 6.8 percent rate.

If the bill becomes law, the rate for all undergraduate Stafford borrowers will be 2.05 percentage points more than the yield on 10-year Treasury note at the last auction before June 1. This year, that yield was 1.81 percent at the May 15 auction, so the Stafford rate for the 2013-2014 academic year would be 3.86 percent.

Graduate Stafford loans would be marked up 3.6 percentage points from the 10-year Treasury yield, with a maximum rate of 9.5 percent. The rate would be 5.41 percent for the coming academic year.

PLUS loans for parents and graduate students would carry a 4.6 percentage-point markup from the 10-year Treasury yield and be capped at 10.5 percent. The rate for the coming year would be 6.41 percent.

Retroactive Rate
The variable rates would be retroactive to July 1. Next week, Republican leaders will ask the House to accept changes made by the Democratic-controlled Senate to the House- passed bill, said Republican aides who spoke on condition of anonymity. The House bill, H.R. 1911, also pegged student loans to annual changes in the yield on 10-year Treasuries.

“I do see it passing the House,” Representative John Kline, the Minnesota Republican who leads the House Education and the Workforce panel, said in an interview. “The faster we do it, the better.”

Opposition of Senate Democrats to variable rates had pitted them against Obama and House Republicans. At a White House meeting last week, Obama, who opposed the House legislation, prodded the bipartisan group of eight senators to reach a compromise. The administration supports the legislation now headed for the House.

Last Holdout
Harkin, the last holdout among the negotiators, went along with the deal after Republicans agreed to cap the interest on all the loans at 8.25 percent.

Opponents of the measure such as Senator Elizabeth Warren, a Massachusetts Democrat, argued that it did little to make college more affordable or reduce the almost $1.2 trillion in student debt. Eighty-five percent of that debt is made up of government-backed loans; the rest were made by private lenders such as SLM Corp., commonly known as Sallie Mae.

“Our students are drowning in debt; we must find a way to address this crisis,” Warren said during floor debate. The measure “asks tomorrow’s students to pay more in order to finance lower rates today,” she said

Harkin, who chairs the Senate Health, Education, Labor and Pensions Committee, said the panel will “revisit the issue” when it drafts legislation to revamp federal higher-education programs and “address the whole issue of college affordability.”

Rate Cap
The measure was passed after the Senate rejected an amendment by Senator Jack Reed, a Rhode Island Democrat, to cap undergraduate loans at 6.8 percent and another by Vermont independent Bernie Sanders to end the variable-rate system in two years. Both failed to get the 60 votes needed to pass under an agreement between Majority Leader Harry Reid and Republicans.

“We are failing millions of families right now,” said Sanders, who caucuses with Democrats. “This legislation will make a bad situation worse.” Sanders cited Congressional Budget Office projections that undergraduate student loans would carry interest rates of more than 7 percent in five years.

Louisiana Democratic Senator Mary Landrieu said she was supporting the measure because the “compromise is much better than the original Republican House version.”

That measure would have provided a 2.5 percentage-point markup from the 10-year Treasury yield for undergraduate loans. It also would have reset the rate each year on the entire amount that students borrow to finance their education.

Under the Senate legislation, a student would lock in an interest rate each year they borrow money for college expenses.

—With assistance from Roxana Tiron in Washington. Editors: Katherine Rizzo, Laurie Asseo

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