Student debt: Looming payments put spotlight on 'real danger' for borrowers
Americans with student debt could see thousands of dollars in interest added to their tabs as part of President Biden's backup loan relief proposal.
The Biden administration is attempting to use a proposed aid program to help millions of student debt holders handle the dual blow of payments resuming in October and the Supreme Court striking down a sweeping debt forgiveness plan.
Biden’s “on-ramp” repayment plan allows borrowers in financial distress to delay payments from Oct. 2023 to Sept. 2024 without the threat of default or credit score decline.
But unlike the current pause on student loans, interest will still accrue on those loans and give borrowers a steeper hill to climb when they begin payments again.
More to come: Borrowers stare down student loan repayments after years of high inflation
Experts are concerned that millions of Americans who leaned on loan relief throughout the pandemic may be caught off guard under the new system.
“I can envision millions of borrowers who are going to be deluded into thinking they don't have to think about their student loans for another year, the same way they didn't have to think about that for the last three years,” said Jonathan Petts, cofounder of Upsolve, a nonprofit that seeks to helps people with difficult financial situations.
“I think there's a real danger for borrowers right now,” Petts said.
Interest could add thousands to a borrower’s debt
Interest on student loans accrues daily, posing a serious challenge for borrowers.
Although the Biden administration has worked to change the way student loan interest capitalizes, a balance could grow substantially in a year’s time.
Interest capitalization occurs when a loan’s accrued interest is added to its principal balance so that future interest then accrues on a higher amount.
The administration proposed a new rule last summer that would limit instances of interest capitalization except when it is required. It is still unclear whether the administration will capitalize loans during the on-ramp period.
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For a borrower with $30,000 in debt, making no payments for a year while the interest accrues would lead to an extra $1,500 on their total, even if it doesn’t capitalize and compound.
“If you're capable of making payments on your loans, you should do so. You shouldn't say, ‘Oh I get another year of not having to pay my loan.’ That would be making a mistake, because it's not really providing financial relief,” student loan expert Mark Kantrowitz told The Hill.
“You're not going to get penalized in terms of ruining your credit,” he continued. “But if you are able to make the payments on your loans, you should do so just try to get rid of the debt as quickly as you can.”
Turning on payments after surging inflation
More than 40 million borrowers are facing repayments that now will feel the added strain of stubborn inflation.
Prices rose 3.8 percent annually in May, according to the personal consumption expenditures (PCE) price index. While inflation has fallen sharply from a 7 percent annual rate in June 2022, it remains well above the Federal Reserve's target of 2 percent.
Inflation has increased the cost of goods and services ranging from housing prices to gasoline costs to grocery bills, and student debt might only exacerbate the burden for many — especially for lower income households.
“People should not be incurring interest during this 12-month on-ramp period. So, I highly urge the administration to consider suspending those interest payments,” Rep. Alexandria Ocasio-Cortez (D-N.Y.) said after the president’s announcement.
The administration argued it were not able to extend the payment pause again because of a provision in the debt ceiling deal Biden made with Speaker of the House Kevin McCarthy (R-Calif.) that required payments to resume this fall.
“The law requires us to end the payment pause this summer. We believe in the rule of law, and plan to follow it,” a White House official previously told The Hill.
'On-ramp' tricky for borrowers in timed-repayment plans
Along with interest accrual, borrowers need to be aware if they are enrolled in programs such as Public Service Loan Forgiveness, which allow their loans to be forgiven after a certain number of years.
The current three-year pause on loan payments still counts towards a person’s time towards loan forgiveness. That will not be the case under the on-ramp repayment plan.
Art Young, executive director of the University of Arizona Office of Scholarships and Financial Aid, says this is the “biggest negative impact” in Biden’s plan.
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Young said his office is urging students to reach out to their loan servicers, make sure they have explored all repayment options and that their contact information is up to date.
Borrowers have options as the Biden administration is implementing new programs that could help cover interest payments and lower the monthly payment a person makes on their loans.
The administration said eligible borrowers can enroll in the REPAYE plan, which will be converted to the SAVE plan this fall.
The new plan will cut monthly payments from 10 percent of discretionary income to 5 percent and ensure unpaid monthly interest won’t cause a borrower’s debt to grow if they’ve been making their monthly payments.
“What that means is the federal government is willing to say, ‘Hey, you might not be making your full monthly payment in this program, but you will not accrue interest in the same way you would in a 10 year standard plan or another similar plan where interest accrues,’” Will Sealy, the CEO of fintech and certified B-corp Summer, a group that helps student loan borrowers navigate their debt.