How rising student loan interest rates could affect college-going behavior

 The interest rates on new graduate loans from the U.S. Department of Education now top 7% while those for undergraduate loans have reached over 5%, the highest levels they’ve been in over a decade. 

That’s partly because the Federal Reserve has been combating elevated inflation by raising its benchmark interest rate to the highest level in over two decades. This has indirectly made the cost of borrowing money through all sorts of avenues more expensive, which typically makes loans less attractive to individuals and firms.  

But when it comes to students, that may not be the case. 

Higher education experts say little evidence demonstrates that higher interest rates will affect where borrowers choose to attend and how much they take out in loans. And with the Biden administration’s new income-driven repayment plans, the role of interest rates in higher education financing is weakening. 

“The interest rate is actually less relevant than it’s ever been,” said Jason DeLisle, a nonresident senior fellow at the Urban Institute, a left-leaning think tank. 

Though interest rates can make a big difference in how much a borrower pays on their loan over their lifetime, colleges typically show students what they would pay monthly on their debt. That could dampen any emotional reaction, said Daniel Pianko, managing director at Achieve Partners, a private equity and venture capital firm.

“On a monthly basis it doesn’t feel like a lot,” Pianko said, though the higher payments may have a bigger impact on those who are already debt-sensitive.

A new landscape

A major factor potentially diminishing the power of interest rates over borrower behavior is the new SAVE plan, an income-driven repayment scheme that stands for Saving on A Valuable Education.

First announced last August, SAVE is more generous than previous income-driven repayment plans. Unpaid interest is eliminated each month and borrowers with low debt can have their loans forgiven after just 10 years. It also lowers the monthly payment borrowers must make, from 10% of their discretionary income to 5%. 

High interest rates may mean that more borrowers opt for the new SAVE plan over the standard repayment scheme, said Preston Cooper, senior fellow at the Foundation for Research on Equal Opportunity, a right-leaning think tank. 

That’s because rising interest rates on federal student loans will only affect payments on standard plans. Monthly payments on income-driven repayment plans, on the other hand, are based on discretionary income. 

“They will not raise monthly payments on the IDR plan, with the result that the IDR plan may look comparatively more attractive,” Cooper said.

The Education Department opened the SAVE plan to borrowers in late August and partnered with a handful of grassroots organizations to conduct an outreach campaign to get the word out. As of Sept. 9, more than 4 million borrowers have signed up for the new plan, the agency said. 

But how much that number will grow is still up in the air. The new plan has attracted the ire of Congressional Republicans, who argue the measure is financially irresponsible. They introduced a resolution earlier this month to roll back the plan, though it’s unlikely to gain traction in a divided Congress. 

The plan’s final roll out will in part determine the response from borrowers.

“It matters how many people know about it and whether they’re able to access the forms online,” said Sarah Sattelmeyer, project director for higher education at New America, a left-wing think tank. “That’s an important new variable in the conversation and we just don’t have the data to know the outcomes yet.” 

A crisis of faith

Despite the waning importance of interest rates to student loan borrowers, it’s likely that high rates will contribute to the public’s growing perception that higher education is unaffordable and in crisis.

The overall price of higher education has led to a crisis of faith in the current system.