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Student debt in the US explained: what’s happening with loan reliefs

Interest on student loans will start accruing on loan balances from September 1, 2023, and payments will resume in October

A student walks on the street in New York City.
A student walks on the street in New York City.Alexander Spatari (Getty Images)

Student loans are a type of installment loan for students to pay for college and its related costs. They were first offered in 1958 under the National Defense Education Act and then became more broadly available under the Higher Education Act of 1965, which aimed to encourage greater social mobility by giving opportunities to people who couldn’t afford higher education.

While these loans have proven advantageous to numerous students over time, recent years have witnessed a surge in concerns surrounding student debt. Students across the nation have been significantly impacted by this issue, leading to a variety of reactions, including protests asking for debt relief.

To address this, the Biden administration proposed a plan to reduce the monthly payments of many low and middle-income borrowers. However, the Supreme Court rejected the program.

Since 2020, payments on student debt have been on pause. As they will resume in the next few weeks, we explain what’s happening with student loans, with an overview of this type of installment loans.

What are student loans?

Student loans are a form of installment loan that allows students to borrow money to pay for their education and pay it back later with interest and sometimes other fees. There are federal and private loans; the government provides the former while private entities like banks offer the latter, and depending on the type of loan, the interest rate is calculated.

Federal loans are available through the U.S. Department of Education. To apply, students must submit a Free Application for Federal Student Aid (known as FAFSA). These loans don’t require a credit check and their interest rates are set by federal law, being typically lower than private loans. These are the federal loan options, depending on the financial need of each student.

Direct Subsidized Loans

Offered to undergraduates based on their financial need. The loan amount depends on school year and independence status. These loans have government-subsidized interest, meaning interest doesn’t accumulate while in school or during deferment, but it starts accruing after the student leaves school.

Direct Unsubsidized Loans

Open to undergraduates, graduates, and professionals regardless of financial need. Interest accumulates throughout all periods as they are unsubsidized.

Direct PLUS Loans

Accessible to graduate/professional students and parents of dependent undergraduates for costs not covered by other forms of aid. A credit check is necessary for PLUS loans.

Direct Consolidation Loans

This option combines multiple federal student loans into one with a single interest rate and servicer. While it can lower monthly payments by extending the repayment period, it might result in more interest paid over time.

Private student loans

Private student loans are offered by banks, credit unions, and online lenders. Unlike federal student loans with fixed rates and maximum amounts, private loans have varying terms. Lenders usually establish borrower criteria, with higher credit scores (around 670 or higher) obtaining better rates. This can make it challenging for undergraduates due to their limited credit history, often requiring a co-signer’s involvement. However, there are instances where students can secure private loans without a co-signer.

How do interests work in student loans?

Interest is a fee charged by lenders when lending money, typically a percentage of the borrowed amount. Student loans can have fixed or variable interest rates. Fixed rates remain constant throughout the loan period, while variable rates change based on certain economic conditions.

For most student loans, interest starts accumulating as soon as funds are received. This means that loans taken during freshman year gather interest while the student is in school. If payments are deferred until after graduation, the owed amount will surpass the original borrowing. An exception is federal subsidized loans, where the government covers interest while the borrower is in school or during deferment.

When making a student loan payment, funds initially address accrued interest since the last payment. The remaining amount then reduces the loan balance. Initially, a considerable portion of payments covers interest charges, but this shifts as the loan decreases over time.

Interest on student loans accrues daily and can become capitalized at specific intervals. Capitalization involves adding accrued interest to the loan balance, causing interest to accumulate on previous interest.

Why do some people struggle paying student loans?

High loan amounts, limited income, unemployment, interest accumulation and economic hardships are some of the factors that lead to challenges in paying off student loans for many individuals. Their debt then accumulates interest, which makes it harder to pay.

U.S. student loan relief pause

During President Donald Trump‘s administration, in March 2020 at the beginning of the Covid-19 pandemic, the government established a pause on payments and interest for student loans. The temporary measure was implemented to offer financial relief to people during that complicated time.

When do student loan payments resume?

Interest on student loans will start accruing on loan balances from September 1, 2023, and payments will resume in October

Biden’s student loans plan

The Biden administration launched a new income-driven repayment (IDR) plan online called the Saving on Valuable Education (SAVE) plan. This plan aims to reduce monthly payments for low- and middle-income borrowers and provide a quicker path to loan forgiveness. The Department of Education launched a beta website where borrowers can apply for SAVE online.

Although the full features of the program will be active by 2024, the application process is currently open to refine the processes before the official launch. Applicants can choose the option for their loan servicer to place them on the plan with the lowest monthly payment, typically the SAVE plan. If an application is submitted during the beta testing period, it will be processed without requiring resubmission. Applying during the summer will ensure that the application is processed in time for the first payment due date in the upcoming fall.

The site is being launched despite the Supreme Court rejection of President Joe Biden’s one-time $411 billion debt relief program, which would have made borrowers who earned less than $125,00 ($250,000 for married couples) able to qualify for forgiveness of up to $10,000 of outstanding federal loans. If borrowers had already received Pell Grants to pay for part of their education, they could have been eligible for up to $20,000 of loan forgiveness.

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