US President Joe Biden.
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Biden formally launched the new income-driven repayment plan, known as the SAVE plan.
One of its benefits would prevent unpaid interest from building on a borrower’s original balance.
Interest capitalization often keeps borrowers in repayment without being able to touch their principal balance.
Student-loan borrowers can officially apply for President Joe Biden’s new income-driven repayment plan, and if implemented effectively, it could take on an issue that causes balances to surge.
On Tuesday, Biden’s administration announced the formal launch of its SAVE plan intended to lower borrowers’ monthly payments, ensure those making under $15 an hour can get $0 payments, and prevent unpaid interest from growing on a borrower’s balance.
The last point addresses an issue known as interest capitalization, in which accrued interest is added to the original loan balance, and future interest grows based on that higher amount. If a borrower cannot make the necessary monthly payment to stay on top of that interest, it could keep their balances growing — and make it difficult to even touch the original amount they borrowed.
For example, Insider previously spoke to a borrower who originally borrowed $79,000 in student loans, has paid back about $175,000, and still owes over $200,000 due to interest capitalization.
The new SAVE plan would work to prevent that from happening. Biden’s Council of Economic Advisors released a blog post on Tuesday outlining some of the benefits of the new plan, and it said that “one of the biggest new benefits to borrowers is how the SAVE plan handles unpaid interest.”
“Under previous IDR plans, some borrowers making their required monthly payments still saw their total loan balances grow, especially in the early years of repayment. When monthly payments amounted to less than interest costs, that unpaid interest would accumulate—and in some cases would become part of the principal, upon which interest could further compound,” the blog post said, describing interest capitalization.
“Under SAVE, this will no longer occur: any interest not covered by a borrower’s monthly payment is not charged as long as the borrower makes their minimum required payment in that month,” it added.
The CEA noted that many borrowers would end up paying the same total amount regardless of the interest benefit because IDR plans forgive borrowers’ balances after at least 20 years of qualifying payments. Because of that, however, the benefit would represent “a relatively small fraction of the estimated budgetary cost of the SAVE plan,” and it would ensure borrowers would not see their balances surge over the course of repayment.
Aside from the SAVE plan, the Education Department had previously announced plans to tackle growing interest on borrowers’ balances. Last year, it released 750 pages of regulatory proposals the department wanted to implement, and one of them included limiting interest capitalization only to instances where it would be specifically required within the Higher Education Act. For example, the department proposed removing capitalization on loans entering repayment following a grace period, along with capitalization during forbearance periods, among other things.
The formal launch of the SAVE plan comes as the student-loan payment pause is about to end after over three years. Interest will begin accruing again in September, and borrowers’ bills will start becoming due in October. Another form of relief the department announced is a 12-month “on-ramp” period during which borrowers who miss payments once the resumption starts will not be reported to credit agencies, but interest will still build during this time. The department is also in the process of implementing a new broad student-debt relief plan after the Supreme Court struck down the administration’s original plan in June, but it could take a while due to the negotiated rulemaking process.