The Cost of Eliminating the In-School Interest Subsidy on Federal Student Loans

Last year’s House Budget Resolution proposed charging students with financial need interest on their subsidized loans while they are still in school and using that money to reduce the deficit. In other words, the House Budget proposed increasing student debt to reduce government debt. Unfortunately, many expect that next week’s House and Senate Budget Resolutions will propose this change again, despite growing public concern about rising student debt and broad consensus on the importance of higher education and postsecondary training to the US economy.

Currently, undergraduates with financial need are eligible for subsidized Stafford loans, which do not accrue interest while students are enrolled at least half time or during the first six months after students leave school (the “grace period”). Eliminating this in-school and grace period subsidy (i.e., charging interest during these periods) would increase the cost of college by thousands of dollars for undergraduate students with financial need.

The charts below illustrate how much more a student would have to pay if the in-school and grace period interest subsidy were eliminated, assuming the student starts school in 2015-16, borrows the maximum subsidized student loan amount ($23,000), and graduates in five years.

Using current CBO interest rate projections, eliminating the in-school and grace period interest subsidy on subsidized Stafford loans would cause this student to enter repayment with $3,750 in additional debt due to accrued interest charges. As a result, she would end up repaying $4,900 (16%) more over 10 years and $6,900 (16%) more if she repaid over 25 years.

The added costs to students will be even higher when interest rates in the economy rise from their current levels, which are still historically low. If the undergraduate Stafford loan interest rate hits the statutory cap of 8.25%, eliminating the in-school and grace period interest subsidy on subsidized Stafford loans would cause this student to enter repayment with $5,700 in additional debt due to accrued interest charges. As a result, she would end up repaying $8,350 (25%) more over 10 years and $13,450 (25%) more if she repaid over 25 years.

At a time when higher education has never been more important or more difficult to afford, we should not be trying to balance the budget on the backs of students. We need to be doing more, not less, to keep college within reach for all Americans.

Note: More than four in five (82%) undergraduates with subsidized loans also have unsubsidized loans. If this student borrowed unsubsidized loans in addition to her subsidized loans and entered repayment with more than $30,000 in debt, she would qualify for a 25-year repayment plan