For more than a decade, Robert Layton has been making payments on the roughly $128,000 he borrowed to pay for college and graduate school. In that time, he estimates, he’s paid about $63,000 — of which $45,000 went toward interest.
But the current balance on his government-owned loans stands at $219,000.
Layton, who works in IT, graduated in 2009. In the years since, he’s mostly paid back his loans using income-driven repayment, a program that borrowers can use to pay down their debt as a percentage of their income. He has opted for that program, instead of a more aggressive payment plan, because it’s what he can afford. But Layton’s monthly payments often aren’t high enough to pay down the interest, which on his government-owned loans is as high as 8.5%.
The experience of throwing money at the loans while watching the balance grow makes Layton feel like he’s “just treading water,” the 39-year-old said. He has put off having children and buying a new car because of the debt.
“The interest on it, it feels like it’s something I can never catch up to,” Layton said. “I can’t make any progress on these loans. It really makes you feel sort of hopeless.”
For many student-loan borrowers, Layton’s experience might feel familiar. In 2020, only about 38% of borrowers were making progress on their loans, compared with 5.6% of borrowers who saw their balances stay stagnant and 42.6% who actually saw them increase, according to research published in June by the Jain Family Institute, a nonprofit research organization.
After a three-year respite from that dynamic during the COVID-era pause on student-loan payments, interest and collections, interest began accruing again on Sept. 1. For borrowers, interest can often be one of the most troubling aspects of their student loans: Not only does it make the debt more complicated to manage, it also raises questions about the government’s aims with the student-loan program.
Over the past several years, some policy makers and experts have also expressed concern about the way the government approaches student-loan interest. At many points since the student-loan program’s inception, lawmakers have used interest rates as a lever to carry out various political priorities, including funding grants, paying third-party companies involved in the student-loan program and rightsizing the cost of the student-loan portfolio.
“We need to understand the government as [both] a lender and as a policy maker, and [that] they kind of have competing interests in you as a borrower,” said Louise Seamster, an assistant professor of sociology and African-American studies at the University of Iowa.
On the one hand, “in terms of investing in you as someone pursuing higher education for all the reasons that benefit the government, they want to make repayment reasonable,” Seamster said. But some steps that could help borrowers the most, including not charging interest, “run against the government’s material interest in receiving financial flows which are primarily through interest,” she added.
Student-loan interest rates have shifted over time
Over the decades of the student-loan program’s existence, the interest rates charged by the government have shifted, but the philosophy behind tacking interest onto the loans has remained the same. Though the idea behind the loan program is that the government subsidizes debt to make financing available to people who couldn’t otherwise afford college, policymakers don’t want the government to appear as if it’s losing money on the loans.
Any time Congress creates a loan program, budget scorers tell lawmakers whether or not the program costs the federal government money, said Robert Shireman, the director of higher education excellence and a senior fellow at the Century Foundation, a progressive think tank.
“The loan program is not free,” Shireman said. “Even if it all gets paid back, it has to be paid back with interest, because economists attach a time value of money.”
The financial principle of the time value of money says that having a dollar today is worth more to the government — or any other person or entity — than having it in a few years. Any delay in the government getting its money back has to be compensated through interest.
“That economic concept is part of government budgeting,” Shireman said.
In 1958, when the government got into the student-loan business for the first time, lawmakers set interest rates “at a level that felt right to them,” Shireman said. At the time, that was 3%. Once the student-loan program shifted in the 1960s largely to one in which private lenders handed out the funds, but the government provided them with a guarantee that they wouldn’t lose money, policy makers began to tie interest rates to a market indicator.
Though a connection to the market remained — interest rates would typically be based on Treasury-bill rates plus a certain number of percentage points — policy makers tweaked interest rates over the course of the guaranteed-student-loan program based on certain priorities, Shireman said. In some cases, they might want more money to pay for Pell grants, the funds the government provides to low-income students to attend college. In other cases, they might need the money to subsidize the lenders and other organizations participating in the guaranteed-student-loan program, he added.
Once the government moved to its current system of lending money directly to students, policy makers’ thinking around the role of student-loan interest had more to do with how much revenue they expect the loans to bring in, he said.
Past congressional battles inspire new push for 0% loans
One of the more recent battles over interest-rate policy led Rep. Joe Courtney, a Connecticut Democrat, to believe it’s possible to change student-loan interest rates to be more beneficial to students and borrowers, he said in an interview.
“The branch of government that actually has the responsibility to address this issue is the House and the Senate, and I’ve seen it happen in the past,” he said.
In 2013, Congress passed a bipartisan bill to prevent student-loan interest rates from doubling after the expiration of a 2007 law that had reduced the rates. The 2013 legislation, signed into law by President Barack Obama, put in place the current formula for how interest on student loans is calculated. Each year, the new rate is based on the May 10-year Treasury-note auction yield plus a certain percentage, depending on the type of loan.
Loans students are taking out to pay for this upcoming academic year have the highest rates in several years. Undergraduate students will pay 5.5% in interest, graduate students will pay at least 7.05% and parents will pay 8.05%.
The combination of this increase in rates for new loans and the resumption of student-loan interest has made it “blindingly obvious” to Courtney that “Congress has really got to take a look at this and act,” he said.
In July, Courtney introduced the Student Loan Interest Elimination Act, which would set interest rates for existing federal student loans at 0%. New borrowers wouldn’t pay more than 4% in interest, with rates based on a sliding scale tied to financial need. The majority of new borrowers would receive a 0% interest rate under the plan, his office said.
Courtney said he’s reached the point where “the interest cancer” for student-loan borrowers has to be removed.
“For most people in this country, even those who are uncomfortable with debt forgiveness, getting rid of interest is a consensus position,” he said. “In past events where Congress actually acted, we were in a similar situation to what we’re in today, which was sort of a countdown.”
Courtney’s bill aims to avoid battles over its cost by creating a mechanism to pay for it. Under his plan, the government would invest borrowers’ principal payments into risk-free assets, creating a trust fund. That money would then be used to cover administrative costs and issue new loans.
Bob Hildreth, the co-founder and co-chair of the Hildreth Institute, a research and policy nonprofit focused on higher education, came up with the fund’s design. To Hildreth, who worked on debt restructuring as an economist with the International Monetary Fund, not charging interest is a key component of the plan, because interest can make it complicated for borrowers to manage their loans.
When borrowers realize “they pay $500, and only $50 of that goes to lower their principal and the rest goes to interest, it’s very discouraging,” he said.
Interest looms over borrowers
In some ways, student-loan interest has become less relevant for government budget projections over the past few years, even as it continues to loom over borrowers. That’s because a large share of student-loan dollars — about 47% in 2022 — are in income-driven repayment plans.
Like Layton, many borrowers under these plans make payments that don’t touch the interest on their debt. As a result, in both the borrower’s eyes and the government’s, a borrower’s balance continues to tick up. If a borrower’s income stays too low to service the debt, then theoretically, they’ll have their balance canceled after at least 20 years of payments.
From the perspective of government budget estimators, the amount that’s canceled is tallied as a loss, and it looks bigger because high interest rates and low payments fueled its growth. In these cases, student-loan interest doesn’t serve as a tool to raise revenue for other priorities, because the government isn’t collecting on it anyway. Instead, it’s only operating as a mechanism to grow a phantom balance that it can be disheartening for borrowers to watch increase, advocates say.
That dynamic is part of a “shell game” that budget estimators play when accounting for the student-loan program, said Mike Pierce, the executive director of the Student Borrower Protection Center, an advocacy group. In projecting the student-loan program’s revenue, modelers often fail to take into account the cost of all eligible borrowers receiving cancellation and other benefits they’re entitled to, he said.
“All of that is baked into the model over time in a way that makes the program basically take credit for cheating people out of their rights,” he said.
Then when borrowers do take advantage of benefits or receive cancellation at higher rates than expected, that appears as a cost to taxpayers, he said. In reality, it’s just the government bringing in less revenue than it expected originally. Pierce described that cost as “the government doing its job: helping eligible borrowers invoke their rights to debt relief under the law.”
“At some point, Congress needs to do some work here and recognize that the student-loan program is a giant mess, and the accounting for it doesn’t make any sense,” he said.
The Biden administration recently took steps to protect borrowers from the experience of watching their balance grow. Under a new income-driven repayment plan called SAVE, the government won’t charge any interest that the borrower’s payment doesn’t cover.
For Layton and borrowers like him, the plan is helpful in the sense that they’ll no longer watch their balances grow. “At least it’s not getting worse,” he said. “It’s a step in the right direction.”
But his balance likely still won’t come down.
“You’re being squeezed by this interest, and it doesn’t feel like there’s anything to do about it,” he said. “You kind of just sit there and hope that the government will decide that it’s gotten bad enough that they’ll try to fix it.”
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