Three and a half years of interest relief for federal student loan borrowers ended Friday — but borrowers have new options when they start making payments.
Key receivers
- Federal student loans began accruing interest on Friday, ending an unprecedented three-year hiatus that began when the pandemic hit.
- Borrowers who use the new savings income-driven repayment plan can avoid accruing interest on the loan.
- New rules prohibit most situations in which interest is compounded on loans, meaning borrowers who fall behind on payments won’t have to pay interest on interest.
From March 2020, for the first time, the Department of Education began charging interest on 38 million direct loans held by the government. Starting in October, borrowers will have to make the necessary payments again that were put on hold as part of the pandemic relief measure.
Accumulating interest over the years can be a huge financial burden for borrowers, even for some who keep making payments, increasing their loan balances. Between 2010 and 2014, 56% of borrowers who began repaying their student loans saw their balance increase between the time they went into repayment and 2017, according to a Congressional Budget Office report — a phenomenon that can leave borrowers feeling discouraged and hopeless about paying back their loans.
Although President Joe Biden’s plan to forgive up to $20,000 in debt per borrower was struck down by the Supreme Court in June, the administration has made several changes to the student loan system to eliminate interest payments and prevent balances from growing.
The SAVE scheme
Borrowers can sign up for a Save Plan, a new type of income-based repayment plan that keeps borrowers from accruing interest as long as they make their payments.
Balloon interest has particularly hurt borrowers previously on income-based repayment plans. Unlike traditional loan repayment plans, IDR plans set a payment rate based on the borrower’s income and forgive the remaining balance after 20 to 25 years of repayment. Borrowers whose payments are not enough to cover the interest even as they are on the path to forgiveness continue to see their loan balances rise.
As long as borrowers make payments, that can’t happen in the new savings plan because no interest is charged on the monthly repayment amount.
Borrowers can sign up for a SAVE plan on the Department of Education website, and those with a REPAYE plan will be automatically switched to it.
Capitalization of interest is limited
A little-known rule change by the Department of Education now limits when student loan interest can be capitalized or added to the loan balance.
As interest increases, it increases the total amount the borrower owes. In certain cases, the accrued interest is added to the loan balance, which means that interest is being paid on the unpaid interest. That can quickly create a loan, the prospect of borrowers having trouble making payments.
Under the new rules, interest does not accrue when a borrower first goes into repayment, leaves forbearance or exits multiple income-based repayment plans.
