Are 0% interest student loans better than $10,000 cancellation?

"I think this COVID pause has really illustrated — hopefully for policymakers but definitely for consumers — that the interest is what's really killing people," says Betsy Mayotte, president and founder of The Institute of Student Loan Advisors.

She's talked to many borrowers who say they wouldn't turn down forgiveness but would much rather have a cut in the interest rate.

The Biden administration is expected to announce $10,000 in cancellation to federal student loan borrowers earning less than $150,000 for individuals and $300,000 for couples. This aligns with the president's campaign promises but falls short of what some experts think is necessary.

Lodriguez Murray, United Negro College Fund senior vice president for public policy and government affairs, encourages "the administration to go bigger and bolder."

"When there is a way you can reset the course of history for certain populations, you should," Murray says.

Tomas Campos, CEO and co-founder of debt optimization software Spinwheel, thinks 0% student loan interest could be a realistic solution. Student loan debt "impacts half of American households. They may not be in debt themselves, but they see their loved ones struggling with it," says Campos.

According to a recent NPR poll, the majority of the general public supports partial student loan relief, but that support decreases with higher amounts of cancellation.

Here's how eliminating student loan interest could work based on two existing proposals aimed at borrowers with problematic long-term debt.

Two plans for 0% interest

LOAN Act

Last summer, U.S. Sen. Marco Rubio, R-Florida, reintroduced the Leveraging Opportunities for Americans Now Act. This act, first introduced in May 2019, calls for the government to disburse all federal student loans at 0% interest and replaces interest charges with a one-time origination fee.

Under the LOAN Act, undergraduate student loans would carry a 20% origination fee, and PLUS loans would carry 35%. These fees would be added to the total principal amount and paid back over the life of the loan.

Borrowers would automatically be placed in an income-driven repayment plan but would have the option to select the standard 10-year repayment plan. Those who repay their loan early would be refunded some of the origination fee.

If a student borrows $27,000 in federal loans at the 2022-23 interest rate of 4.99%, their payment would be about $286 a month for 10 years, with $34,349 repaid in total. With a 20% origination fee and no interest, that borrower would have $270 monthly payments with a $32,400 total repayment.

Low-income borrowers who enter an income-driven repayment plan would benefit most. According to a NerdWallet analysis, a borrower with $27,000 in debt and a starting annual salary of $30,000 would pay nearly $42,000 by the time income-driven repayment forgiveness kicked in. With the Rubio proposal, that borrower may pay about $9,600 less.

Zero-Percent Student Loan Refinancing Act

Rep. Joe Courtney, D-Connecticut, introduced the Zero-Percent Student Loan Refinancing Act in 2021. Sen. Sheldon Whitehouse, D-Rhode Island, introduced a version of the bill to the Senate earlier this year.

The Zero-Percent Student Loan Refinancing Act would automatically refinance all loans under the federal Direct Loan program to 0% interest. It would also give borrowers with Federal Family Education Loans, Perkins loans and Public Health Service Act loans the option to refinance to 0% interest.

Borrowers with private student loan debt would be eligible for the 0% refinance, too, according to email statements from Meaghan McCabe, a senior communications advisor with Whitehouse's office

This proposal was introduced to help student loan borrowers recover from pandemic-induced financial strain and mounting interest totals that have the potential to exceed the original principal loan balance. The proposal would allow borrowers to refinance at 0% through 2024.

Borrowers would be eligible to refinance anytime during the open window of the program, even if they are still in school, according to McCabe. Under this proposal, a student who refinanced immediately and had $27,000 in debt at 4.99% interest would save about $7,349 over a 10-year term.

What can you do now?

The existing proposals are a long way from coming to a vote in either house of Congress, and there isn't even consensus on whether 0% is the ultimate answer to the student debt crisis.

Interest-free student loans "can be coupled with other actions, really, but it's not enough to make a real difference," says Murray.

Mayotte says a reduced interest rate, maybe 1%, across student loans may be a better solution, as borrowers may not take 0% debt seriously. She also believes student loans with reduced interest rates have a better chance of garnering bipartisan support in a divided Congress.

Meanwhile, federal student loans are scheduled to return to repayment in September, and that means interest charges will also resume.

Borrowers should plan for repayment. If you think you'll struggle, contact your servicer to discuss your options, such as reduced payments or halting payments altogether through forbearance. No matter how you proceed, however, interest charges will continue adding up.

As for interest-free or reduced-interest student loans, Mayotte urges borrowers to make their voices heard. She says, "I think if more consumers start writing their members of Congress asking for that, we might get some more attention and more legs to it."