Could 0% interest rates settle the student loan debate?
THROUGH Jason armesto24 November 2021, 15:09
Students on UCSB’s Santa Barbara campus as some students face statewide student housing crisis, as seen in November 2021. (Al Seib — Los Angeles Times / Getty Images)
Student debt has become a topic of national conversation, and for good reason: since 2003, total student debt increased by more than 600% to $ 1.7 trillion. The burden of this debt has fallen on the shoulders of most college-educated American adults, with 65% of them still repay their student loans.
Many people argue that the solution is for the federal government to completely write off the debt. President Joe Biden has listened, at least to some extent, his administration has canceled more than $ 11 billion in student loans since taking office.
Still, some critics say it didn’t go far enough, while others think the debt cancellation is unfair to those who have never been to college. While the debate over canceling student debt rages on, there is much less talk about canceling federal loan interest rates. Why not? This is a question that Ben Carlson, director of institutional asset management at Ritholtz Wealth Management, addressed in a blog post in August.
“It’s an interesting idea, but I haven’t seen where it gets anything from,” says Barry Coleman, vice president of counseling and education programs at the National Foundation for Credit Counseling. “I have not seen any proposal from the federal government other than a simple forgiveness for those who have already borrowed.”
Could tackling interest rates offer a compromise in the debate over what to do about student debt? Here’s what two experts said Fortune.
Why the government charges interest on student loans
The federal government does not charge interest on student loans to make a huge profit. It does this to offset the costs of lending money, including inflation, and because lending money is risky. Some people will default on their loans, which means lost revenue for the government, so the federal government reduces its risk of losing money by charging interest.
Whether earning minimum wage or having inherited millions, any student who takes out a federal student loan pays the same rate of interest. For undergraduates, this rate is currently 3.73%, and that’s 5.28% for graduate students. The rate adjusts each spring and is linked to the current yield on 10-year treasury bills. This formula for setting interest rates is relatively new.
“Congress set the interest rate on the loan by choosing a rate that it saw fit that day. It was literally so ridiculous, ”said Jason Delisle, senior policy researcher at Urban Institute. In order to change interest rates, the House, Senate, and President all had to agree on a new rate – a slow and inefficient process that meant student loan interest rates rarely changed. During the Great Recession, it became evident that this strategy had problems.
Despite the drop in interest rates for other federal loan programs in response to financial difficulties, student loan interest rates remained at 6.8%, a figure that Congress had set itself aside. agreement in 2002. “It started to become clear that the rates had nothing to do with what was going on in the economy, and now the rates adjust according to the year you take out a loan” , explains Delisle.
How 0% interest would benefit students
To see how much money a student spends on interest, let’s do some quick math.
If you took out a $ 50,000 loan over 10 years, your monthly payments would be around $ 500 at the current federal undergraduate interest rate (3.73%) versus $ 417 if you were not paid. invoice. Over the life of the loan, that’s a savings of almost $ 10,000, an amount that can make a big difference in someone’s life.
“It would cover the rent. It might be easier for some to qualify for mortgages, ”Coleman said. “If they have more debt, maybe they could pay off that debt faster just because they don’t have to worry about the extra interest added to federal student loans.”
Eliminating interest rates would also eliminate the possibility of interest capitalization, which occurs when interest is not paid and essentially consists of itself. “This is where people really start to feel trapped and not make any progress in paying off loans,” says Coleman. While claiming that forbearance from delaying payments may be tempting to young people, Coleman and the NSCC are urging borrowers to come up with a plan to pay off their debt as quickly as possible instead of kicking the box. “This is where we see people getting into trouble,” he warns.
How much would students really save?
The problem with the hypothetical math above is that most students don’t take out $ 50,000 loans. For the 2019 promotion, the average student loan debt for undergraduates was $ 28,950. So, for a student who takes out that average amount spread over 10 years, what difference would 0% interest make to 3.73%?
People with high debt could save a lot of money if interest was waived. But the reality is, most students don’t take out loans large enough for the interest to have a profound impact.
“I would be surprised if a 3% interest rate on a student loan could make or break someone’s decision to go to college,” Delisle says.
But what about graduate students? They pay higher interest rates than undergraduates, so setting their rate at 0% would save them more money. But the interest rates for higher education are higher because these borrowers can largely afford it. Generally speaking, the more people have an advanced degree, the more money they have, as well as the earning potential.
The cost of 0% interest
While 0% interest might give students some financial relief, Coleman notes someone should foot the tab for lost government revenue. “If it were only zero, I think it would fall on the backs of taxpayers because the program is not self-financing.”
Delisle agrees. “Taxes should go up or the government should cut spending on something else,” he says. And going further, he notes that student interest rates are already quite low. At 3.73% today, the rate is comparable to a mortgage, although student loans are much easier to acquire. “There is no credit check, there is no collateral requirement, there is no down payment. So in that regard, it’s pretty remarkable, it’s about the same rate as a mortgage, ”he says.
Meanwhile, borrowing money for free is virtually unprecedented. “Everyone would take out loans because it would be the best deal. That would be the only place you could get a 0% interest rate loan, ”says Delisle. There would likely be an explosion in borrowing, but not necessarily because more people were going to college. Instead, people would take advantage of a rare opportunity.
“That’s what a financial advisor would tell them to do,” says Delisle. “They were like, ‘Look, just keep your savings in a savings account and take out the loan at 0% interest. “” Even if someone had enough money in the bank to pay for their education, they would be encouraged to take the loan instead.
All of this interest-free borrowing would result in a loss of revenue for the government – a loss of revenue that policymakers must find some other way to collect. It is quite possible that taxes will go up, resulting in higher taxes for the very students that a 0% interest rate was supposed to help.
So while eliminating interest rates might sound good in theory, in practice it might be more difficult than it is worth. As long as students don’t fall too far behind on their loans, the interest rate can be negligible. “So make it a priority, make a plan, pay as much as you can for these student loans and get rid of them,” Coleman says. “That way you can focus on saving for other things like buying a house and starting a family.”
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