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By Elvina Nawaguna
WASHINGTON (Reuters) - President Barack Obama on Wednesday proposed shifting federal student loans to market-based rates rather than the current system in which interest rates are fixed by law and subject to congressional whim.
The new interest-rate approach is one of several measures included in President Barack Obama's fiscal 2014 budget proposal to contain growing student loan debt and make higher education more affordable.
The president's budget stands little chance of being enacted into law, but the proposals could help jumpstart congressional debate about reforming student loans.
Obama's plan also calls for making the rate on new federal student loans a market interest rate that would remain fixed for the life of the loan. The proposal calls for expanding repayment options so borrowers do not have to pay more than 10 percent of their discretionary income on student loan bills.
Student loan borrowing has risen as the price of higher education has soared. Americans now owe more than $1 trillion (652.6 billion pounds) in student loan debt. The New York Federal Reserve Bank says delinquency rates have spiked over the past eight years.
In the current system, students pay the same fixed rate, now set at 3.4 percent, regardless of changes in other interest rates in the economy. Some economists and lawmakers have said the system is unfair to students who could end up paying more at a time when overall interest rates are still at an all-time low.
The president's budget comes just months before interest rates are set to double to 6.8 percent on millions of undergraduate subsidized Stafford loans if Congress does not act to once again extend a freeze on rate increases before July.
The U.S. Public Interest Research Group, a consumer group, released a report on Tuesday estimating that millions of students will be forced to pay $1,000 more per year on each loan they take out if Congress allows interest rates to double.
The group said that the federal government, which makes 36 cents on every federal student loan dollar, should not be getting such profits at the expense of students. The federal government issues about 93 percent of U.S. student loans.
U.S. PIRG spokesman Ethan Senack said any approach tying student loan interest rates to market rates should come with protections for students down the road.
"As the economy recovers, interest rates are set to rise - which would leave future students vulnerable to high rates," Senack said.
Obama's budget plan also would set aside $1 billion in grants for states working to improve their higher education and bring down the cost. It proposes creating a $260 million fund to reward states and individual academic institutions that take innovative steps to bring down college costs and improve graduation rates.
The budget would continue funding to the Pell Grant program that provides financial aid to low-income students, and would make permanent the American Opportunity Tax Credit that helps millions of students and families afford college.
(Reporting by Elvina Nawaguna; Editing by Karey Van Hall and Will Dunham)