Of the $1.3 trillion in outstanding federal student loan debt, the vast majority of it (somewhere around $900 billion, maybe more) is federal. One of the biggest hurdles facing federal student loan borrowers right now is high interest rates.
Federal student loan interest rates are set by Congress. While leaders from both parties touted the success of a bipartisan interest rate reduction bill passed by Congress and signed by the President a couple of years ago, this was merely a temporary fix. And the price of that fix is steadily increasing federal student loan interest rates across the board – especially for graduate students, who could see interest rates approach 10% in the coming years.
How big of a difference can a student loan’s interest rate make? Pretty big, to be honest. A $50, 000 federal student loan with an interest rate of 7.5% requires monthly payments of nearly $600/month to pay the loan off in 10 years. The borrower will have paid over $21, 000 in interest at the end of that repayment term. In contrast, if the interest rate was only 2.5%, the borrower could pay off the loan in 10 years with monthly payments of only $470/month. At the end of the repayment term, the borrower with the lower rate will have only paid approximately $6, 500 in interest – a difference of over $14, 000 compared to the higher-rate loan.
This is no joke. Interest rates have real implications for real people.
Student loan advocates both inside and outside government have been calling on Congress for years to permanently lower federal student loan interest rates and allow refinancing to make repayment more affordable, but proposals have gone nowhere. The most promising of these proposals, a bill authored by Massachusetts Senator Elizabeth Warren that would have allowed federal student loan borrowers to refinance their loans within the federal student loan system at much lower rates, failed to attract enough votes in the Senate to overcome a filibuster (and even then, its fate in the House of Representatives would have been far from certain).
While the federal government drags its feet on allowing borrowers to refinance their federal student loans as interest rates continue to creep up, private refinancing companies such as SoFi and Earnest have entered the field. They offer attractive interest rate reductions, and they specifically target graduate student borrowers in fairly lucrative careers like law, medicine, and business. It’s a risky thing to refinance federal student loans into a private student loan, but borrowers making good money increasingly believe it’s worth it, given how much money they are wasting in interest to the federal government.
The problem? One of the reasons the federal government justifies high interest rates on graduate student loans is because graduate students are supposed to earn enough money (in theory) to pay everything back with few problems. These higher returns are then supposed to effectively subsidize the lower-interest undergraduate loans. But the federal government is losing the most stable and lucrative borrowers in its federal student loan portfolio. By keeping graduate student loan interest rates high and refusing to allow borrowers to refinance, why wouldn’t a graduate student loan borrower consider switching to a different lender at a much better rate (even with the risks inherent to leaving the federal student loan system)?
Student loan refinancing companies like SoFi and Earnest are going to continue to pull the most successful borrowers – the borrowers who make the most money and have the strongest ability to repay their loans – out of the federal student loan portfolio. And this will leave the federal student loan system as a whole less stable, and less able to absorb costs and risks. If graduate student loans are supposed to finance (at least in part) undergraduate student loans, where does that leave the system?
The federal student loan business model must change, and the government better catch on soon and allow borrowers to refinance their loans – before it’s too late.