With just two working days left before the U.S. government doubles some student-loan interest rates, lawmakers are haggling over what to do about it.

The argument isn’t over whether to allow rates to rise above 3.4 percent, the level set by law until July 1. It’s about how much borrowing costs will increase.

“The likelihood of students keeping the interest rate they had for the last two years is diminishing by the hour,” said Terry Hartle, vice president for public affairs at the American Council of Education, the largest lobbying group for colleges and universities. “The outcome will be students will pay more than 3.4 percent in the short term,” he said in a telephone interview.

Unless Congress acts, the interest rate for subsidized Stafford loans for undergraduates from low-income families will increase to 6.8 percent from 3.4 percent. More than 7 million students use that direct-from-Washington loan program.

Instead of enacting a law to extend that rate or set a new flat rate, lawmakers have been negotiating ways to let the rate float by linking it to 10-year Treasury notes.

Getting an informal agreement on the concept of flexible rates was the easy part. The more challenging part of the negotiations, according to those involved, has been figuring out how much flexibility to build in, and how much profit the government should extract.

Government Profit

Senate Majority Leader Harry Reid contends that there should be no profit at all.

“The issue is this: Republicans want deficit reduction,” the Nevada Democrat said June 25. “We don’t think there should be deficit reduction based on the backs of these young men and women who are trying to go to college.”

Complicating the talks is the 55 percent increase in the yields of 10-year T-bills, to 2.54 percent, since May 1.

Under a House-passed plan, that would have meant a student loan rate of 4.3 percent, rising to as much as 8.5 percent.

“It’s very clear students would be worse off under that proposal than simply allowing interest rates to double” because rates “would be lower initially but rise as interest rates rise,” said Pauline Abernathy, vice president of the Institute for College Access & Success, a non-profit research and advocacy group based in Oakland, California.

Exploding Debt

Over the past decade, there’s been an explosion of student loan debt. It now totals almost $1.2 trillion, with 85 percent consisting of government-backed loans taken out by students and their parents. The rest are made by private lenders like banks or Sallie Mae, the largest U.S. education-finance company.

The share of 25-year-old Americans with student debt increased to 43 percent last year from 25 percent in 2003, according to the Federal Reserve Bank of New York. During that nine-year period, the average education-loan balance of people in that age group increased 91 percent, to $20,326 from $10,649, according to the New York Fed.

With so much outstanding student debt, borrowers are having trouble contributing to the U.S. economy in other ways.

It has become harder for young people, especially those between 25 and 30, to secure other types of credit, including home mortgages, according to a February report on household debt and credit by the New York Fed.

Economic Drag

Economists warn that what is owed in student loans may rival home-mortgage indebtedness as a drag on U.S. growth.

“The difficulties borrowers face when trying to manage cash flow may have a broader impact on the economy and society,” Rohit Chopra, student-loan ombudsman of the Consumer Financial Protection Board, told the Senate Banking Committee on June 25. “When young workers are putting large portions of their income toward student loan payment payments, they’re less able to stash away cash for that first down payment.”

Private borrowing for student loans grew after Congress overhauled bankruptcy laws and made such debts non-dischargable in personal bankruptcy.

That change meant that “there were very few reasons for banks not to make educational loans to anybody who wants them,” Hartle said. “Most students who get in trouble by borrowing huge amounts of money get there because they have borrowed from private lenders” without the knowledge of their college or institution, he said.

It’s common for students to have more than one kind of loan, taking out the maximum government loan and then supplementing with private loans.

Loan Types

The most popular government loan is the Stafford. Subsidized Stafford loans are limited to students with lower incomes, and the interest rate is 3.4 percent, set by Congress. The government pays the interest during school.

The interest rate will increase to 6.8 percent on new originations if Congress doesn’t act by July 1.

Any undergraduate, regardless of income, can get a Stafford unsubsidized loan at 6.8 percent.

The federal loan limits for undergraduates are $5,500 the first year, $6,500 the second year and $7,500 in the last years. Graduate students no longer dependent on their parents also can take out Stafford loans.

Another type of direct federal loan, called PLUS, carries a rate of 7.9 percent for parents and graduate students.

Obama Presses

While running for re-election, President Barack Obama pressured lawmakers to extend the fixed rates for a year. Republican challenger Mitt Romney joined the call, and Congress obliged both candidates. Congress acted two days before the rate on unsubsidized Staffords would have doubled.

Since then, the president has continued public pressure on Congress to address a pressing problem for students.

“It’s a different year,” said John Kline, the Minnesota Republican who heads the House Education and the Workforce Committee. House Republicans aren’t open to a temporary change, Kline said -- “We’ve already been there.”

The talk about student loans this week hasn’t been limited to federal loans.

Private loans make up about 15 percent of outstanding educational debt. They’re considered riskier because their interest rates are usually not fixed and they don’t offer the same type of protections as federal loans such as income-based repayment when borrowers get into trouble.

A Federal Reserve official told the Senate Banking Committee June 25 that lenders of private student loans should reduce default risk by helping struggling borrowers come up with alternative payment plans.

One of the major lenders, Discover Financial Services, announced yesterday that its fixed interest rate on student loans was dropping to as low as 5.49 percent.

Dueling Plans

On May 23, the Republican-run House passed Kline’s legislation that would tie student loan interest rates to the 10-year Treasury note plus 2.5 percent. In the Senate, Reid tried to round up votes for another extension, and fell short of a required 60-vote supermajority.

Obama has his own proposal to subject the Stafford loans to interest-rate fluctuations and save the government $3 billion over 10 years.

As July 1 draws closer, with Congress planning a holiday recess, a bipartisan group of senators say they’ve come up with a possible breakthrough -- a floating rate for Staffords, the 10-year Treasury borrowing rate plus 1.85 percent.

That proposal still has the deficit-reduction element that Reid opposes; it would pare the government’s red ink by $1 billion over 10 years, according to a statement from West Virginia Democrat Joe Manchin, Maine Independent Angus King, Oklahoma Republican Tom Coburn, North Carolina Republican Richard Burr and Tennessee Republican Lamar Alexander.

Inaction Predicted

Both Senator Tom Harkin, the Iowa Democrat who chairs the Senate Health, Education, Labor & Pensions Committee, and the panel’s top Republican, Alexander, predicted that the Senate would go home for a week-long July 4 break without acting.

Alexander, a former U.S. education secretary, said that if lawmakers can reach a consensus this week, Congress can return July 8 and approve the change retroactively.

Neither party has been able to gain a political advantage over the other for inaction by Congress.

Unlike a year ago, “this issue has much less traction,” said political scientist Bruce Altschuler at the State University of New York at Oswego. “People don’t know who to blame. They know somebody is at fault. They are not sure who.”