According to analysis published by the centrist Brookings Institution, lower student loan interest rates aren’t a great way to make college affordable. But yet Hillary Clinton has made cutting interest rates on undergraduate student loans the central component of her plan to make college more affordable.
Even though interest rates affect the total lifetime cost of a student loan, they have no effect on students when they’re deciding to enroll as undergraduates. “I know of no empirical study that estimates a causal relationship between college enrollment and the interest rate charged on student loans,” writes Susan Dynarski, a nonresident senior fellow at Brookings. This is because students get the same funding from the government regardless of the interest rate, Dynarski says.
Finding ways to lower tuition or give out more grants would be more effective at raising college enrollment than Clinton’s plan to cut interest rates.
Lower interest rates would also be an ineffective way of reducing loan defaults. Loan payment affordability is largely determined by principal, the size of the original loan distribution, not the interest rate. “The ten-year payment on a $20,000 loan is $204 when the interest rate is 4.29%, and drops just twenty dollars (to $184) if the interest rate is cut to 2%. For a seriously distressed borrower, cutting the payment twenty dollars is unlikely to make much of a difference,” Dynarski writes.
Instead of lower interest rates, an income-based repayment plan would reduce student loan defaults. In such a plan, interest rates affect how long it takes to pay off a loan, but not how much monthly payments cost. Income-based repayment plans set payments at a fixed percentage of income.
A version of this exists under the REPAYE Plan, established in December 2015 by the Obama administration, which enables Direct Loan borrowers to cap their monthly student loan payments at 10 percent of their monthly discretionary income. There are also PAYE and IBR Plans, which are generally available to those whose federal loan debt is higher than their annual income.
Dynarski writes, “a well-designed, income-based repayment plan allows borrowers to pay back their loans when and if they are able and is the best route to reducing default and distress.”
Jason Russell is a commentary writer for the Washington Examiner.
