Why exactly does the federal government charge interest on student loans?
Republicans in Congress continue to have a stroke over the $10,000 student debt cancellation announced by President Joe Biden. “RARR working class people shouldn’t be paying college for the elite!” they shout, as if going to college is something relegated only to the Top 1%. (If more people in rural America went to college, the economy and rural communities might not be as depressed by growth as they are now, but I digress.)
I already wrote in a recent column that I think debt cancellation is essentially a do-nothing bribe to try to support young voters before the Democrats sink into an iceberg at mid-term. It does nothing to pay for the cost of college education, or for people who take on new debt tomorrow.
But I had this thought — what if the federal government, which funds the majority of student loans, charged borrowers little or no interest?
Listen to me:
Government has a vested interest in an educated population, hence why we mandate and pay for K-12 education, when we know in the modern economy that almost all net new jobs are created for workers with formal post-secondary education.
The average student leaves college with about $37,667 in debt these days (which makes my $15,000 from Purdue in 2008 look great in comparison).
The 2022 federal interest rate for undergraduate student loans is 4.99%. Granted, it’s still much better than seeking a private loan from a bank, which may or may not lend you at all depending on your credit, but 5% is still 5%.
So, over a typical 10-year term, standard student loan repayment, a student with $37,667 in debt at 4.99% will have monthly payments of $399 and accrue $10,253 in interest, if he pays within the deadlines.
(Coincidence that debt forgiveness is $10,000 and the average student borrower’s 10-year interest is $10,253? Maybe, maybe not.)
That’s a big payback, though, because we know many students early in their careers struggle to make their payments, so they can defer an income-based repayment, which spans 10 years of more. I repaid my loans fairly faithfully after graduation, but made income-reduced payments for a while when I lived in Portland and only made about $1,700 a month, so my refund ended up taking 12 years.
Let’s face it – $400 a month is a big payout, especially for a 22-year-old in his first job at the lowest rung of his lifetime income ladder.
Even if you land a $20 an hour job right out of school, that’s more than 10% of your gross monthly income spent on student loans.
So what if the federal government volunteers to be an even friendlier lender?
If the interest rate on student loans was 1.25% (the lowest this online student loan calculator I was using allowed me to put), monthly payments would be reduced to $334, a savings of $65 per month, while the total repayment would be $40,090 over 10 years. That’s a savings of $7,800.
At 0% interest, the savings would be even greater.
“But Steve, won’t the Feds lose a cash cow bleeding college graduates for interest money?”
Maybe, but you’re required to get some of it back in taxes. With the money graduates aren’t wasting on paying interest, they could be used to buy goods and services, which generates economic activity and sales taxes.
It could help young adults get on a better financial footing, helping them overcome big financial challenges that people in their 20s and early 30s typically face, including marriage, home ownership, and retirement. family.
This could help reduce the number of people who have to slow down their loan repayments, which only prolongs the financial burden of their student loan debt beyond 10 years, sapping their disposable income well into their 30s or even more.
Is this the end of everything, everything to the problem? No of course not.
But as I’ve said many times, I believe the best way to solve a complex problem is to attack it with lots of small, targeted tweaks instead of aiming for one giant, over-the-top, revolutionary overhaul.
Interest on student loans makes money for the government, of course, but at the cost of undermining the purchasing power of those who bear the debt.
By reducing or eliminating interest on student loans, we could encourage more higher education and reduce its cost.