By Elvina Nawaguna and Mark Felsenthal
WASHINGTON (Reuters) - A coalition of Senate Democrats and Republicans have reached a tentative deal with President Barack Obama that would roll back a recent spike in interest rates on new federal loans for college students and instead move the loans to a market-based rate.
Lawmakers are trying to secure a retroactive fix before the next educational year starts, after interest rates on millions of new federal student loans automatically doubled to 6.8 percent on July 1.
Unless Congress agrees on a fix, about 7.4 million students with federal Stafford loans will be affected and could end up paying up to $4,000 more in interest rates for a four-year degree program.
The deal, which followed extensive negotiations on Wednesday, would retroactively move the loans for the coming school year to a market-based rate that would roughly work out to 3.86 percent this year for undergraduates.
Congress currently sets the level of federal student loan interest rates, and critics of the system say it unfairly subjects students to political whims.
"It is refreshing that on such an important issue we stopped playing politics with our students' future to come up with a bipartisan, permanent fix that lowers interest rates for all students," said Democratic Senator Joe Manchin of West Virginia.
The deal would tie interest rates on undergraduate subsidized and unsubsidized Stafford loans to the 10-year Treasury note plus 2.05 percentage points, and plus 3.6 percentage points for graduate loans.
It would cap rates at 8.25 percent for undergraduates, 9.5 percent for graduate students, and 10.5 percent for PLUS loans for parents who borrow to pay for their children's college.
A senior administration official said Obama supports compromise legislation that would hold down interest rates and was involved in the Senate negotiations.
A Democratic official said the measure would not raise money by charging students higher rates and would protect students from future rate rises. Democrats insisted they would not back any plan that uses student loans to fund the budget deficit.
Lawmakers haggled for months over student loan rates but failed to reach a deal before the rates doubled on July 1.
"This compromise is a win-win for both students and taxpayers," said Republican Senator Tom Coburn of Oklahoma. "Tying interest rates to the market allows students to take advantage of historically low rates while ensuring taxpayers will not have to foot the bill for arbitrary rates set by Congress."
Critics of market-based interest rate plans say they would help students immediately, but put them at risk of paying higher interest in the future as the economy improves and rates rise.
Such concerns are compounded by the recent jump in Treasury yields after the Federal Reserve announced that it planned to start scaling back its stimulus program that has kept interest rates low.
It is not clear whether the House of Representatives would move swiftly to approve an agreement like the one reached by the senators, but it passed a similar one in May.
House Speaker John Boehner said he had not yet seen the details of the Senate deal. "But it clearly follows the structure of the House bills. When we see the details, I am hopeful that we'll be able to put this issue behind us."
The Senate is expected to vote on the deal by next week.
(Additional reporting by Richard Cowan and Thomas Ferraro.; Editing by Karey Van Hall and Christopher Wilson)