Most Student Loan Borrowers Might Be Unscathed By Higher Interest Rates

If you’re headed for college, you might be dismayed to see interest rates on new federal student loans have risen to their highest since 2010. 

For many borrowers with student loan balances, however, interest rates could become virtually irrelevant.

Student loan interest rates—set at 5% for undergraduate borrowers for the coming school year—will lose much of their sting if President Joe Biden’s new plan to overhaul income-driven repayment plans goes into effect. 

What's Biden's New Repayment Proposal?

Under Biden’s proposed program, borrowers with new student loans would only have to pay 5% of their discretionary income (defined as income more than 225% of the poverty line) toward their student loans, regardless of how much their balance is or what their interest rate is. After a maximum of 20 years of payments (or 25 for graduate school loans), the loan would be forgiven no matter the remaining balance.

For borrowers who go the full 20 or 25 years and have a balance remaining to forgive, a higher interest rate would neither increase their monthly payments nor the amount of time it will take to repay their loans.

Not only that, but under Biden’s plan, if your income-driven payment isn’t enough to cover the interest on your loan, any extra interest would be forgiven. That means your loan balance can’t increase as long as you’re making payments, unlike under current IDR plans, where many people make payments only to see balances rise because of interest piling up 

Biden’s plan is also much more generous than current IDR plans, which require payments of 10% of income over 125% the poverty line, making the new plan an extremely appealing choice for borrowers.

New Proposal Provides More Relief

The new IDR plans, which the Department of Education plans to begin implementing by the end of the year, mean that very few borrowers would actually have to pay off the balance of their loans.

Among borrowers who get bachelor’s degrees, assuming a $31,000 loan, only 22% would actually pay their loans in full, compared with 59% under current IDR plans, researchers at the Urban Institute estimated in an analysis in January, when Biden’s plan was announced.  Among people who get associate’s degrees costing $13,000, only 11% would fully pay.

While Biden’s proposed income-driven repayment plan hasn’t gotten as much attention as his plan to forgive up to $20,000 of student loan debt—the fate of which is currently being decided by the Supreme Court—it could completely transform the financial landscape for future college students. Typical borrowers would save $2,000 per year in payments compared to current repayment plans, the Department of Education estimates.