Many Student Borrowers are Underwater, Paying Interest on Interest

Even students who continued paying their student loans during the payment pause made little if any progress in paying down the balance.

News Desk

Payday loans are often described as the ultimate form of predatory lending but a new study suggests student loans may be in the same league.

The study found that nearly two-thirds of students who made payments during the pandemic pause were underwater on their loans – meaning they owe more than the original amount of the loan.

“The data reinforces what we already knew: borrowers want to make progress towards repaying their loans, but our broken student loan system has made it difficult, resulting in loan balances that in many cases greatly exceed the original amount borrowed,” said Center for Responsible Lending Senior Researcher Robin Howarth.  

Democratic lawmakers, led by Sen. Elizabeth Warren (D-MA) have been pressing for action by the Biden administration and by Congress to forgive some student debt and reform the scandal-plagued system.

"Our broken student loan system continues to exacerbate racial wealth gaps and hold back our entire economy," said Warren in a statement issued with Senate Majority Leader Chuck Schumer (D-NY) and Rep. Ayanna Pressley (D-MA) earlier this week.

"We continue to call on the administration to use its existing executive authority to cancel $50,000 of student debt. Student debt cancellation is one of the most significant actions that President Biden can take right now to build a more just economy and address racial inequity."

“Servicing errors and lack of federal oversight exacerbate flawed federal student loan policies and leave borrowers, particularly those of color, even more vulnerable. -- Robin Howarth

Not even $1

The Center for Responsible Lending (CRL) and the National Consumer Law Center (NCLC) issued the study. It found that the students who made payments during the payment pause have been unable to repay even $1 of their original loan balance because all of their payments have gone to paying interest.

Of the borrowers who are underwater, one-third owe more than 125% of their original balance, despite making at least one payment during the payment pause enacted by the federal government in March 2020. Of the underwater borrowers:

  • 67% owe 100% to 125% of original balance
  • 26% owe 125% to 150% of original balance
  • 6% owe more than 150% of original balance

"As this data shows, it is unfortunately all too common for student loan borrowers to see their balances go up instead of down while in repayment,” said National Consumer Law Center Attorney Abby Shafroth. “Balances go up when borrowers in financial distress cannot afford to make payments. They also go up when monthly payments in income-driven repayment plans are insufficient to cover interest."

"And unpaid interest is often capitalized, so borrowers pay interest on interest," Shafroth added. "Ballooning balances not only make education more expensive for those who must borrow but make many feel hopeless that they’ll ever be free of their student debt."

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Researchers' Recommendations

The organizations issued these recommendations for providing at least some relief to borrowers:

  • Provide across-the-board debt cancellation: While policymakers have debated system fixes, borrowers’ debt has ballooned, and their financial futures have grown more bleak. In addition to fixing the system going forward, the [Education] Department should provide relief to existing borrowers by providing widespread student debt cancellation and by clearing the books of bad debt.
  • End practices that cause balances to balloon: To stop balances from ballooning, the Department should both (1) expand existing partial interest subsidies in income-driven repayment (IDR) plans by fully subsidizing unpaid interest that would otherwise accrue as a result of IDR payments that are insufficient to cover accrued interest for borrowers with high debt to income ratios, and (2) end interest capitalization, which causes borrowers who experience financial distress to have to pay interest on interest.
  • Provide data: As policymakers grapple with what to do about the student debt crisis, more information about the amount and role of interest in the federal student loan portfolio is needed to better understand the scope of the problem and to assess potential responses.
Student Loan Scheme Victims Getting Refunds
The Federal Trade Commission is sending checks totalling more than $316,000 to nearly 11,000 people who lost money in a student loan debt relief scheme.

The data, produced by the U.S. Department of Education in response to a Freedom of Information Act (FOIA) request, included information on 428,268 Navient borrowers who owe almost $28 billion in student loans and made $600 million worth of voluntary payments.

“Servicing errors and lack of federal oversight exacerbate flawed federal student loan policies and leave borrowers, particularly those of color, even more vulnerable. It is imperative for the Biden Administration to provide immediate relief to existing borrowers with across-the-board student debt cancellation as the Administration works to reduce the wealth gap and get the economy back on a sustainable path.”

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