Though most of the recent conversations surrounding student loan debt have been about forgiveness, some experts say setting federal interest rates at 0% indefinitely could be another helpful way to address the student loan crisis in the U.S.
Typically, federal borrowers can pay between 2% to almost 7% on their student loans (interest rates are tied to the yield on 10-year Treasury notes each spring and vary depending on loan type). For over two years, though, interest rates for most federal loans have been set at 0%.
By forgoing interest payments, borrowers are saving $1.5 billion per month, according to a recent calculation. The benefits of the current interest-free period has prompted some to argue it should be extended indefinitely.
Earlier this year, Sen. Michael Bennet, a Colorado Democrat, urged Biden to keep interest rates for most federal loans interest-free permanently.
“We must do all that we can to ease the financial burden of student loan debt for borrowers who took out loans to pay for college,” Bennet wrote in a letter to the president. “The Administration should use this opportunity to … work with Congress to make systematic changes in the way college students pay for postsecondary education.”
And on the other side of the aisle, Republican Sen. Marco Rubio of Florida has proposed eliminating interest on federal student loan debt and replacing it with a one-time, non-compounding origination fee.
Before the student loan payment pause, millions of borrowers weren’t paying enough each month to even cover their interest payments, never mind pay down the principal. That led to ballooning balances and widespread feelings that borrowers would never escape from under the weight of their debt.
Unfortunately, borrowers aren’t in a better financial position more than two years later. In late April, a survey from U.S. News & World Report found that 37% of borrowers said they won’t be able to make federal student loan payments starting this fall, if the pause isn’t extended again.
Not only would setting rates at 0% save borrowers billions on interest, but with all of a borrower’s payment going toward the principal, they could pay their balances off much faster. That would help many borrowers feel like they’re doing more than simply “treading water” when they make a payment each month, says Michael Kitchen, senior managing editor at Student Loan Hero, a loan resource site. They could avoid interest capitalization, or when interest compounds on itself.
“You wouldn’t have these shocking cases that appear sometimes, ‘Oh I’ve been paying off loans for 50 years,'” Kitchen says. Borrowers would be able to “pay off their loans in a matter of years rather than decades.”
And the benefits would extend beyond their student loan debt. Mentally, they’d feel like they were making progress with their repayments and might be more inclined to start planning sooner for other financial goals, says Isabel Barrow, director of financial planning at Edelman Financial Engines.
“When a borrower has to make a decision between paying down their student loan debt, or saving for retirement, a first home, or another financial event, they often can’t move forward with these goals until their student loan debt is paid off or well managed,” says Barrow. “When the interest is 0%, this reduces the monthly minimum payment, meaning the borrower may be more likely to qualify for a mortgage, or have more disposable income to spend on building wealth or saving for retirement.”
The proposition is also likely more palatable to critics who say student debt forgiveness isn’t fair and that borrowers need to be held responsible for their debts, Kitchen says.
“It’s hard to think of really anything that would be totally free of controversy, but it doesn’t carry the really strong emotions that dollar figure forgiveness carries,” he says.
This plan has its critics, too
That said, not everyone is on board with interest-free student loans.
Unlike other types of loans—say auto or a mortgage—there’s nothing the government can use as collateral with a student loan. And since the government will pretty much lend to anyone who wants to finance a college education, it could face issues if some borrowers skip payments (which is common). Interest offsets the costs of lending money and helps the government meet increasing higher education costs.
Without the interest payments, the government would have to find some other way to pay for the loans, such as by raising taxes or cutting spending elsewhere.
Plus, federal student loan rates are relatively low, compared to other types of loans. For current undergraduates, they stand at just 3.73%. For the average undergraduate who has $28,950 in student loan debt, the difference between paying 0% interest and 3.73% over 10 years is just under $50 per month.
Still, cutting interest rates to zero would help millions of borrowers struggling to make their payments or watching their balance grow over time, rather than decrease as they make payments. Just paying the minimum each month can slow borrowers down, says Kitchen, but that’s often all they can afford to pay. This is particularly true for those on income-driven repayment plans, in which their monthly payments are based on their income. The monthly payment may be so low that not even all of the interest that accrues each month is paid off.
“The minimum payment is set at a level that will keep you in debt in perpetuity,” Kitchen says. “The people in the middle, the ones [for whom] it’s a slog but they’re able to keep up with the payments, they would really benefit from being able to pay off their loans more quickly.”
All of this said, it’s not at all clear what Biden will do in the coming weeks, though some level of widespread forgiveness seems likely.
“We’re really still in the dark about what they’re going to propose,” says Kitchen. “Hold tight and wait and see what happens.”
