Subsidized Stafford Student Loans are Already Interest-Free for the Unemployed

This post was first published as a response to a prompt on the National Journal’s Education Experts Blog on May 1, 2012. The prompt and responses from other experts can be viewed on the National Journal’s website here.

It’s important to think about “what protections [for borrowers] would be needed,” if Congress made changes to the interest rates on federal student loans. Even so, it seems hardly anyone understands the protections borrowers already get under the current federal loan system. What else could explain President Obama and Mitt Romney’s mutual misunderstanding that charging lower interest rates on Subsidized Stafford loans helps borrowers who can’t find a job?

Subsidized Stafford loans for undergraduates – the only type eligible for the 3.4 percent interest rate – include a special interest-free benefit. The interest clock on these loans is frozen while a borrower is enrolled in school and for up to three years if a borrower is unemployed or meets the rules for economic hardship. This means that keeping the interest rate on newly-issued Subsidized Stafford loans at 3.4 percent will not affect unemployed borrowers. The interest rate for these borrowers is automatically 0.0 percent.

Borrowers working part-time or in low-paying jobs need not worry about the interest rate on Subsidized Stafford loans (for three years) either if they enroll in the income-based repayment plan. This plan caps a borrower’s monthly payment at a share of his disposable income, regardless of the interest rate on the loans. But the deal is even sweeter for Subsidized Stafford loans. If a borrower’s monthly payment is too low to cover the interest that accrues, the government forgives it – up to three years’ worth.

These protections make the rhetoric about lowering interest rates to help college graduates weather a weak job market ill-informed at best. By definition, the campaign to keep interest rates lower on Subsidized Stafford loans is about keeping rates lower only for those borrowers who are employed and earn enough to be ineligible for the income-based repayment program. It is those fully-employed borrowers who are most able to swing the extra $9 a month (at most) that another year of loans offered at a 3.4 percent interest rate would otherwise save them.

Targeting a precious $6 billion right now to borrowers who have jobs and incomes high enough to cover the higher rate seems out of touch, especially when the Pell Grant program needs approximately that much next year to stave off a massive cut to the aid it provides.