In response to the coronavirus pandemic, President Trump announced that he would waive interest on student loans held by federal government agencies. The reason for such a waiver is to put extra money in the pockets of student loan borrowers. But the way the policy is structured, it will provide little immediate relief to borrowers, while potentially increasing costs after the pandemic ends.
The Ministry of Education had not issued any official guidelines regarding the student loan policy of interest at time of writing. But Ron Lieber, New York Times Financial Columnist reports that monthly student loan payments will not decrease at all due to the policy, according to conversations with ministry spokespersons. The president of an association of student loan managers said the same thing in a interview with Kery Murakami from Inside Higher Ed.
The interest relief will prevent student loan interest from accruing while the policy is in effect, but the monthly payments will remain the same. This will prevent balances from increasing while the waiver is in place, but most borrowers will only see a benefit once they are about to repay their loans.
How would that work? Let’s say you have $ 15,000 left on your student loan, which carries an interest rate of 5%. You make payments of $ 283 per month. About $ 60 of this goes to interest, while the rest goes to principal. At this rate, you will fully repay this loan over five years and your payments will total $ 16,984.
Now imagine that the federal government waives your interest for the next three months due to the coronavirus pandemic. You still make a monthly payment of $ 283, but for three months it will all be used to pay off the principal rather than the interest. Due to the reduced interest charges, your payments will total $ 16,750.
This equates to a saving of $ 234, which does not make sense for many households. But the borrower will not realize these savings for five years, when he repays the loan. It doesn’t help much for borrowers facing a cash shortage due to the pandemic. But it will cost the federal government money later, hopefully once the pandemic is over.
The interest exemption on student loans could make borrowers who are facing financial difficulties feel better about suspending their loans. In forbearance, borrowers do not have to make payments, but regularly scheduled interest continues to accumulate. Watching your balance increase can be overwhelming, so waiving interest could lead borrowers to make this choice. But the policy still provides no cash relief today, as most borrowers were still eligible for forbearance, pandemic, or no pandemic.
The interest exemption on student loans fails to help distressed borrowers today, although the federal government will still incur costs related to lost interest income in the future. This makes it a poor response to the financial pressures the coronavirus pandemic has placed on American households.
Even if the Trump administration found a way to cut monthly payments today, it would still be a poorly targeted response to the pandemic. Student debt is concentrated among high-income households; rich families hold about $ 3 in student debt for every dollar held by poor families. But low-income people, who are more likely to have service-sector jobs affected by the pandemic, are most in need of financial assistance.
A better way to help people who have been hurt financially by the pandemic is to send money directly to them, rather than providing delayed and inconsistent relief through the student loan system. Fortunately, the White House announced Tuesday afternoon that he was working on a plan to do just that. President Trump should reconsider his flawed student loan interest waiver and instead spend the money in direct relief for families who need it most.