What higher interest rates could mean for the student debt crisis – The Hill
The story at a glance
- The Treasury Department on Wednesday announced a new, higher interest rate of 4.99% for subsidized and unsubsidized undergraduate loans.
- Some federal student loans start accruing interest as soon as the loan is disbursed, accrued over the life of the loan.
- Lawmakers and advocates have argued that federal student loans should be interest-free.
Interest rates on student loans will climb this year to levels not seen since before the pandemic after the Treasury Department announced a new set of rates on Wednesday for incoming students considering taking out loans for the next school year. .
The new rate of 4.99% is a considerable jump from last year’s rate of 3.73% for direct subsidized and unsubsidized undergraduate loans. The department reevaluates interest rates each year, with student loans being part of the 10-year note auction.
The decision comes as the country grapples with an ongoing student debt crisis and adds to the debate over whether to eliminate interest-based student loans.
Interest rates worsen student debt
Interest is at the heart of the national student debt crisis and advocates and lawmakers have pushed to eliminate it altogether because it adds to the volume of student debt held nationally.
Some federal student loans, such as graduate loans and parent PLUS loans, begin earning interest as soon as a loan is disbursed and may continue to accrue during a deferment period. Regardless of whether a borrower makes monthly payments or not, interest continues to accrue.
Many borrowers end up with surprisingly high interest balances that are not far off the principal balance of their loan, making it all the more difficult to repay. It’s a process known as amortization, when loan repayments are spread over a period of time and result in monthly payments covering only current interest balances.
Principal balances remain intact, and even more interest continues to accrue.
This process has allowed student debt to skyrocket, Kevin Miller, associate director of the Bipartisan Policy Center, told Changing America.
“Especially with people who have been in debt for 10 or 20 years, many of them have stories of how they owe more than they originally did, despite having already repaid as much as their original loan,” Miller said.
This makes no sense to Miller, who also noted that federal student loans are meant to be an investment in the workforce and that borrowers should not be trapped in a system that results in owing far more than what which was originally borrowed.
Among adults with debt, 93% say they borrowed to pay for their own education, while 81% say they borrowed to pay for a child or grandchild’s education, according to the Education Data Initiative.
Elimination of Interest Rates on Federal Student Loans
One proposed solution to the persistent problem of student debt is to completely eliminate interest on federal student loans.
Sen. Marco Rubio (R-Fla.) has been pushing for this reform since 2019, before reintroducing his “Loan Act” legislation in August of last year. The bill suggests instituting a one-time finance charge instead of charging interest, which would be paid over the life of the loan and not accrue with age.
These finance charges would be fixed, meaning they would not increase over time, and all borrowers would automatically be placed in an income-based repayment (IBR) plan. Borrowers would only pay 10% of their income above 150% of the federal poverty level. Any borrower earning less than 150% of the federal poverty level would not have to pay monthly payments on their loan.
“Working-class Americans should be able to pursue an education without having to worry about becoming trapped in an insurmountable cycle of debt for years after graduation,” Rubio said in a statement.
An imperfect solution
Sandy Baum, a senior fellow at the Urban Institute’s Center on Education Data and Policy, told Changing America that an upfront payment might not make sense for all borrowers.
For example, some borrowers may be able to repay their loans quickly, but would still be charged the same upfront fees as someone who takes 10-20 years to repay theirs, while bringing them closer to full loan forgiveness under certain conditions set by the federal government.
The elimination of interest will also impact borrowers differently depending on the amount of money they are able to borrow.
“But the problem with that is that graduate students can borrow essentially an infinite amount of money. So, if you borrow $5,000, the interest rate will not be a considerable amount of money. But if you borrow $200,000, the idea of $20,000 going to med school interest-free, that’s a huge giveaway,” Baum said.
Instead of eliminating interest altogether, Baum thinks the federal government should consider not charging interest on the first $10,000 a borrower needs. This would help those who have only borrowed a small amount of money while charging interest to high income earners like medical and law students.
In an analysis for the Urban Institute, Baum and Donald Marron point out that the federal government borrows money when providing student loans because they are treated as valuable financial assets that should earn interest along with principal repayments. .
For those who already have existing loans with the federal government, the Treasury Department’s new rate hike won’t affect them, but it will cost more for students planning to take out loans this summer for the 2022-23 school year. and throughout the life of these loans.
Private loans are also expected to increase, as they generally have higher interest rates than the federal government. In 2019, the average rate for a co-signed private loan was 10.2%, while the federal government fixed interest rate was 4.53% for subsidized direct loans for undergraduates in the same year . About 16% of student loans in 2019 were held by individuals.
Although President Biden has indicated he is prepared to forgive up to $10,000 of federal student loan debt per borrower, it is unclear whether reforms to how interest rates are charged federal student loans are under consideration.
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Published in May. 12, 2022