Student Loan Update: Big Changes To Interest Are Coming
Much of the ongoing national discourse surrounding student loan debt has been focused on student loan forgiveness and repayment. But student loan interest has also been a major concern for many borrowers. There are some potentially major changes on the horizon that will impact how student loan interest works, and these reforms may benefit many borrowers.
Here are the details.
Student Loan Interest Capitalization Reforms
The Biden administration finalized new regulations last fall that will touch nearly every aspect of the federal student loan system, including a number of student loan forgiveness and repayment programs.
One of the more significant reforms under the new rules is a limiting of future interest capitalization events. Interest capitalization is a process where accrued, unpaid interest is added back on to a student loan’s principal balance, causing more interest to accrue on that larger balance. Interest can accrue during periods of nonpayment (such as forbearances and some deferment periods). And under income-driven repayment (IDR) plans, interest can accrue in excess of a borrower’s monthly payment. That accrued interest can then be periodically capitalized in a variety of circumstances. Interest capitalization can result in student loan balances increasing at a frightening rate.
The new regulations, set to go into effect on July 1, will limit future interest capitalization events. According to the Education Department, capitalization will no longer occur in the following instances:
- When a borrower first enters repayment;
- When a borrower leaves a forbearance;
- When a borrower in the Pay As You Earn (PAYE) plan no longer has a partial financial hardship or leaves the plan;
- During periods where a borrower’s monthly payment is less than the amount of monthly interest accrual while the borrower is in certain IDR plans or on an alternative repayment plan;
- When a borrower defaults.
Importantly, the rule change won’t prevent interest from accruing, but it will stop accrued interest from capitalizing in the above situations. Furthermore, the reforms will only limit future interest capitalization; interest capitalization that already occurred would not be reversed.
Still, limiting future interest capitalization will go a long way towards mitigating future balance increases for many borrowers.
Biden’s New Student Loan Repayment Plan Stops Excess Interest Accrual Entirely
Separately, last month the Biden administration released proposed new regulations overhauling the Revised Pay As You Earn (REPAYE) plan, one of several income-driven repayment plan programs. The proposed reforms will lower monthly payments and accelerate student loan forgiveness for many borrowers.
One of the other significant benefits of the new plan, however, is that interest would no longer accrue in excess of a borrower’s monthly payment. In other words, if a borrower’s calculated monthly REPAYE plan payment is less than the amount of monthly interest accrual, any excess interest would be waived. This would prevent interest from accruing entirely for borrowers who have low-enough income to have a calculated monthly payment of $o. For other borrowers, it will stop their loan balance from increasing while they are in the plan.
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In a letter sent to the Biden administration last Friday, several dozen Congressional Republicans criticized the proposal, arguing that waiving excess interest goes beyond what federal statutes authorize. “Congress intended to provide the administration with specific flexibility regarding regulations on capitalization, but explicitly did not provide flexibility on interest accrual in this particular repayment plan,” they wrote. Notably, however, the REPAYE plan has waived at least some interest accrual for many borrowers since it was first created in 2015. And other income-driven plans waive interest accrual during certain circumstances, as well.
The Biden administration has not announced a firm timeline for when the changes to the REPAYE plan will go live.
Interest Will Start Accruing Again When the Student Loan Pause Ends
While the Biden administration’s student loan interest reforms may benefit many borrowers, one potentially adverse event looms on the horizon. The national student loan pause is about to enter its third year. The pause has suspended payments, as well as interest accrual, for government-held federal student loans since March 2020.
Biden’s most recent extension of the student loan pause is set to end within 60 days of either June 30 or whenever the Supreme Court rules on Biden’s one-time student loan forgiveness plan. If Biden does not issue another extension, interest will start accruing for borrowers once again.
Further Student Loan Forgiveness Reading
Student Loan Forgiveness: Biden Administration Updates Form For New, Easier Bankruptcy Process
Will House Republicans ‘Reverse’ Student Loan Forgiveness And End Student Loan Pause?
Student Loan Forgiveness: These Deferment And Forbearance Periods May Count