Editor's Note: This article was originally published by Real Clear Policy on September 29, 2022, and is crossposted here with permission.
The Biden administration may be going through with debt forgiveness, but don’t think this is the end of the matter. Outstanding student debt could quickly return to the current $1.6 trillion level by 2028. Lawmakers will need to contend with the issue again.
Loan forgiveness is the easiest option, but most seem to agree it’s misguided, as conservatives and liberals have united in their criticism of the measure. As a result, politicians will wisely avoid the infamous “debt forgiveness” tag in the future. Instead, they will opt for less politically alienating policies such as interest-free student loans.
Senators Sheldon Whitehouse (D-RI) and Marco Rubio (R-FL) and Congressman Joe Courtney (CT-02) have all already introduced bills that would eliminate student loan interest for a temporary period of time or with stipulations. Rep Eric Swalwell (D-CA) wants to go even further and cancel student loan interest permanently, a move that resonates with many borrowers.
Lawmakers frame 0% interest as a moderate proposal that gives borrowers the chance to work hard to repay the original amount without worrying about the pesky, insidious interest rate. It appeals to those who view debt jubilees as massive handouts to the “quiet quitting” generation. Eliminating interest appears like a less radical reform that saves money in the long-term.
But interest-free student lending is just debt forgiveness by a different name.
When somebody borrows a loan, the lender expects the full amount repaid. The lender for federal student loans is the federal government — or more accurately, American taxpayers. Just as Americans lose money when debt is forgiven, they also lose money when the interest isn’t collected. This is due to inflation, where the value of money decreases over time. A $10,000 loan in 2012 is worth only ~$7,900 in 2022.
In other words, a borrower with $10,000 in student debt in 2012 and zero percent interest would receive around 20% forgiveness just due to devaluation of the dollar by 2022, provided no payments are made. Thus, zero percent interest would encourage borrowers to delay repayments as the principal devalues over time.
Another reason to keep interest rates is the opportunity cost of lending money. Whenever a lender issues a loan, that is money that can't be used for anything else at that time. Borrowers pay interest to compensate the lender for that opportunity cost. If the government stopped collecting interest, student loans essentially become another taxpayer expense with no expected return.
Even worse, interest-free student loans would be regressive, as it shifts costs from those who enjoy the financial benefits that stem from having a college degree to those who aren’t.
Zero percent interest primarily benefits those who borrow the most, which tend to be high-income professionals. The primary beneficiaries of the $155 billion payment pauses during the coronavirus pandemic were doctors and lawyers.
Interest-free student loans fail to address why so many borrowers struggle with repayments in the first place. Instead of protecting vulnerable borrowers from future regret, 0% interest encourages students to borrow more to participate in the desperate rat race for a degree. With relaxed lending standards, universities will continue to be the expensive gatekeepers to good jobs. Abolishing interest would maintain the status quo when it should be changed.
A better approach would reform student loan lending practices to deny future loans to students unlikely to pay back their debt. Federal loans should be restricted based on a student’s major and their academic preparedness. Those with greater chances of completing their programs and those who will enter in-demand fields should receive access to more generous loans. Borrowers must prove to taxpayers that their investments are worth the costs.
Interest-free student loans benefit the higher education system and the wealthy. But it is not in the interest of most Americans.