Want to solve the student debt crisis? Restructure interest rates

More than 43 million Americans owe nearly $1.8 trillion in student debt, and that’s only expected to grow. While debate has raged over what the Biden administration (and/or Congress) should do about student loan forgiveness, little has been done to address the issues that created the crisis in the first place.

One way to simultaneously help Americans struggling with student loan debt and fix the financial systems responsible for the crisis is to restructure student loan interest rates.

The COVID-19 pandemic has elevated discussions of student loan forgiveness to the forefront of American discourse. Proponents argue that debt cancellation would mitigate the harmful effects of student debt on the economy, such as reduced homeownership rates, and improve income inequality for students of color. Opponents argue that a partial forgiveness would do little to spur economic growth and that the forgiveness, in general, would not address the underlying drivers of rising student debt and would disproportionately benefit households. high income.

No matter where you stand, there seems to be little compromise in sight. Restructuring student loan interest rates may be that middle ground.

Interest rates are at the heart of the student debt crisis, as interest begins to accrue as soon as a loan is disbursed and continues through deferment periods. This interest continues to accumulate and, over time, leaves borrowers with huge balances and monthly payments that only cover current interest balances. Any unpaid interest is capitalized and added to the principal of the loan, thus increasing the overall cost.

Sixty-three percent of borrowers who made student loan repayments during the COVID-19 pandemic still owed more than they originally borrowed, despite interest rates set at zero percent and payments suspended. If we are to solve the student debt crisis, we must first face the reality that interest rates will only make the student debt problem worse if we do not act.

Subsidized loans were designed to avoid high interest rates because the government would cover the cost of interest while a student was enrolled. However, freshmen can only receive $3,500 in subsidized loans, barely a third of the average cost of public tuition in the state ($10,338).

This leaves many students, including graduate students, dependent on unsubsidized loans, which accrue interest from the time they are disbursed until payment, regardless of enrollment, deferment and grace periods.

We need to address the idea of ​​students paying interest on their loans before they complete their degrees/credentials. Nowhere else in our financial system does someone start paying interest on something before they receive the goods they took out the loan for. Take a mortgage – live in the house. Take a car note – drive the car.

Students don’t see a return on their investment until they are able to engage in gainful employment after graduation. Even students who work full-time or part-time while in college only benefit from their degree/title after completing the program.

Why should they pay interest before that?

One way to solve the interest rate problem and find a compromise: let borrowers refinance their loans at zero percent interest or eliminate interest rates altogether. There are glimmers of bipartisan support for this idea.

In August 2021, Sen. Rubio (R-Fla.) reintroduced his Leverage Opportunity for Americans Now (LOAN) Act that would eliminate interest rates and replace them with one-time, non-compounding fees. Similarly, in June 2022, Sen. Sheldon Whitehouse (DR.I.) introduced the Zero Percent Student Loan Refinance Act, which would allow Americans to refinance their federal student loans at a zero interest rate. percent.

A zero percent interest rate would address many of the concerns expressed by both sides about completely canceling student debt. This would allow borrowers to better plan their finances without overheating the economy, as full forgiveness could. This would begin to tackle one of the main drivers of rising debt (i.e. interest rates) and reduce the financial burden on low-income people without disproportionately benefiting those who have loans for higher and professional studies. Not to mention the many unintended mental and social benefits that borrowers would see from feeling a sense of relief.

The Biden administration has yet to be so bold in suggesting a zero percent interest rate, but recently it has suggested changes to prevent unpaid interest from being capitalized on the loan principal in certain circumstances. This narrower approach would save borrowers millions but still does not solve the burgeoning debt crisis.

Regardless of what the administration and Congress decide, it’s clear that they have to do something – and do it quickly. Several generations are now grappling with the weight of student debt and growing balances. Students who make payments barely cover interest charges and see principal balances continue to rise. Without action, this problem will only grow.

A key part of the American dream is the idea that if you work hard, a better future is possible, but the student debt crisis is clouding that dream for millions of Americans. Many borrowers feel under water, fearing for their financial future while others eagerly await a move from the Biden administration as their last hope.

There is no perfect answer to the crisis, and it will take more than a political solution to address it. However, restructuring interest rates—or, better yet, eliminating interest altogether—would provide the light at the end of the tunnel that so many Americans seek, and it would bring us closer to realizing that American dream.

Javaid Siddiqi, Ph.D. is President and CEO of The Hunt Institute.