Could 0% interest rates settle the student loan debate?

WITH Jason ArmestoNovember 24, 2021, 3:09 p.m.

Students at UCSB campus in Santa Barbara as some students face a nationwide student housing crisis, as seen in November 2021. (Al Seib — Los Angeles Times / Getty Images)

Student loan debt has become a topic of discussion nationally and for good reason: Since 2003, total student loan debt has increased by more than 600% at $ 1.7 trillion. The burden of this debt has fallen on the shoulders of most college-educated American adults, with 65% of them still pay student loans.

Many people argue that the solution is for the federal government to cancel the debt permanently. President Joe Biden has heard, at least in part, that his government has forgiven more than $ 11 billion in student loans since taking office.

However, some critics say it has not gone far enough, while others believe debt relief is unfair to those who have never been to college. While the debate over student debt relief continues, there is much less talk of canceling interest rates on federal loans. Why not? This is a question posed by Ben Carlson, Ritholtz Wealth Management’s director of asset management, in a suspension in August.

“It’s an interesting thought, but I’ve not seen where it attracts,” said Barry Coleman, vice president of counseling and education at National Credit Counseling Foundation. “I have not seen any proposal coming out of the federal government other than a simple pardon for those who have already borrowed.”

Could dealing with interest rates offer a compromise on the debate over what to do about student loan debt? Here is what two experts said Luck.

Because 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 cost of borrowing money, including inflation, and because borrowing money is risky. Some people will default on their loans and this means a loss of revenue for the government, so the federal government reduces the risk of losing money by charging interest.

Whether they make a minimum wage or have inherited millions, every student who gets a federal student loan pays the same interest rate. For undergraduates this percentage is currently 3.73%, and is 5.28% for postgraduate students. The interest rate is adjusted every spring and is linked to the current yield of the 10-year government bonds. This formula for setting interest rates is relatively new.

“Congress used to set the interest rate on the loan by choosing an interest rate that they thought looked good that day. “It was literally so ridiculous,” said Jason Delisle, a senior policy fellow at Civil Institute. In order to change interest rates, Parliament, the Senate and the President had to agree on a new interest rate – a slow, inefficient process that meant that student loan rates rarely changed. During the Great Depression, it became clear that this strategy had problems.

Despite falling interest rates on other federal loan programs in response to the financial crisis, student loan interest rates remained at 6.8%, a figure agreed by Congress in 2002. “It has become clear that interest rates have nothing to do with “What happens in the economy and now interest rates are adjusted based on the year you take out a loan,” explains Delisle.

How the 0% interest rate would benefit students

To see how much money a student spends on interest, let’s do some quick math.

If you take out a 10-year loan for $ 50,000, your monthly payments will be about $ 500 at the current federal undergraduate interest rate (3.73%) versus $ 417 if you do not charge interest. During the life of the loan, this is a saving of almost $ 10,000 — an amount that can make a significant difference in one’s life.

“It would cover the rent. “It might make it easier for some people to qualify for mortgages,” says Coleman. “If they have another debt, they might be able to repay it faster just because they do not have to worry about adding extra interest to federal student loans.”

The abolition of interest rates will also eliminate the possibility of capitalization of interest, which occurs when interest remains unpaid and substantially burdens themselves. “People there really start to feel trapped and make no progress toward repaying their loans,” says Coleman. While arguing for late payment may be tempting for young people, Coleman and the NSCC are urging borrowers to develop a plan to repay their debt as soon as possible instead of kicking the box. “There we see people getting into trouble,” he warns.

How much would students really save?

The problem with the above hypothetical math is that most students do not take out $ 50,000 loans. For the class of 2019, The average student loan debt for undergraduate students was $ 28,950. So for a student who gets this average amount split over 10 years, what kind of difference would the 0% interest rate make compared to the 3.73%?

People with a lot of debt could save a lot of money if interest were eliminated. But the reality is that most students do not take out loans that are large enough for interest to have a profound effect.

“I would be surprised if a 3% interest rate on a student loan would make or break someone’s decision to go to college,” says Delisle.

But what about the graduates? They pay higher interest rates than undergraduates, so if they set the interest rate at 0% they will save more money. But interest rates for graduate school are higher because these borrowers can largely afford it. In general, the more advanced the degree that people have, the more money they have — along with the ability to earn.

The cost of interest 0%.

While the 0% interest rate could offer students some financial relief, Coleman notes that one should take the card for lost government revenue. “If it was just zero, then I think it would fall on the backs of taxpayers because the program does not pay for itself.”

Delisle agrees. “Taxes should be raised or the government should cut spending on something else,” he says. And to go a step further, he notes that student interest rates are already quite low. At 3.73% at present, the interest rate is comparable to a home loan, although student loans are much easier to obtain. “There is no credit check, no security requirement, no down payment. “So from this point of view, it’s rather remarkable that it’s about the same rate as a mortgage,” he says.

Meanwhile, free money lending is practically unprecedented. “Everyone would take out loans because it would be the best deal. It would be the only place where you could get a 0% interest rate loan, says Delisle. There would probably be an explosion in lending, but not necessarily because more people would go to college. Instead, people will take advantage of a rare opportunity.

“That’s what a financial advisor would tell them to do,” Delisle claims. They would say, “Look, just keep your savings in a savings account and let ‘s get the loan at 0%.” instead of the loan.

All this interest-free borrowing would result in a loss of revenue for the government – lost revenue that policymakers must find another way to recover. Taxes are likely to increase, resulting in higher taxes for the students themselves who were intended to help with a 0% interest rate.

So while eliminating interest rates may sound good in theory, in practice it could be more of a problem than it’s worth. As long as students do not lag far behind in their loans, the interest rate can be negligible. “So prioritize, develop a plan, pay as much as you can for these student loans and get rid of them,” says Coleman. “This way you can focus on saving on other things like buying a house and starting a family.”

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