Daniel Tapia, 41, earned his bachelor’s degree in dental hygiene more than a decade ago. But since then, his financial situation has been far from easy.
“I am financially paralyzed by crippling debt and unable to move forward in life,” Tapia previously told Insider. “Killed by the student loan industry.”
To afford his degree, Tapia had to take out both private and federal student loans, and while he originally borrowed $60,000, his balance is now $86,000 and growing. This is thanks to the interest on the debt that continues to be added to his principal balance, thus increasing the amount of debt that accumulates in what feels like an endless spiral. This prevents him from even touching the original amount he signed up to borrow.
What Tapia experienced with her student loans is far from unusual. Insider spoke with over two dozen borrowers who reported the crushing burden of student debt they have, largely caused by interest capitalization. For some, this can be exhausting, keeping them in a never-ending repayment cycle. During the pandemic, however, most federal borrowers were exempt from rising interest rates thanks to the student loan repayment pause, which canceled interest rates and is set to expire after Aug. 31.
Although President Joe Biden’s Department of Education has yet to confirm whether there will be another extension, it has released a list of regulatory proposals it plans to tackle next year, including reforms to major student loan forgiveness programs that provide relief for college dropouts with debt but no degree, and a cap on interest capitalization — all likely to be implemented after Biden implements broad student loan forgiveness for federal borrowers.
“What I’m not getting is that I’ve withdrawn a certain amount and I’ve already paid that amount and I still owe more than I originally owed, that’s just crazy,” Tapia said. “It’s mind-boggling to me that this total is not going down. It won’t go away.”
Biden’s proposal to address growing interest
Interest capitalization occurs when accrued interest is added to the original loan balance and future interest accrues based on that higher amount. This is something the Department of Education hopes to prevent where possible through its proposed regulations.
According to the department’s 750-page preamble to the regulations, interest capitalization is most often triggered after periods of student loan deferment or forbearance. The Department proposes to restrict capitalization to cases where this is specifically required by the Higher Education Act. The preamble states that this would result in a loss of revenue as there would be fewer capitalization cases, therefore increasing the cost to the government and US taxpayers.
“However, the proposal is expected to result in lower overall payments over time for borrowers, thereby increasing the likelihood that borrowers will repay their loans in full,” the preamble said. “Given this benefit, the Department believes that the benefits to borrowers outweigh these costs and justify the change.”
The Higher Education Act states that interest capitalization can occur when the loan enters repayment, when a grace period expires, when deferment or forbearance periods expire, and when the borrower defaults. The department currently capitalizes unpaid interest annually during any period of negative amortization—in which the borrower fails to cover the interest owed on the loan—and seeks to end capitalization cases that are permitted but not required by law.
Specifically, the department wants to remove:
- Capitalization of interest on loans maturing after a grace period
- Interest Capitalization on Direct Loans During Forbearance Periods
- Annual capitalization of unpaid interest when the borrower’s income-driven repayment plan does not cover the accrued interest
- Capitalization of interest on an overdue loan
The department says it does not remove capitalization when required by law, including when a borrower exits a grace period on an unsubsidized loan or when a borrower on an income-based repayment plan no longer has partial financial hardship.
In its explanation for proposing the rule, the department noted the “financial and psychological challenges” that accompany the growing interest.
“The act of accruing unpaid interest to a borrower’s principal balance can be a frustrating experience for borrowers who are confused about what triggered capitalization or are surprised by the higher amount they owe because of capitalization,” the preamble states. “Borrowers also often express disappointment and surprise at interest capitalization, at least in part because it is not an event they are likely to have experienced with other financial products.”
The proposed rules will enter public comment for a period of 30 days, and the department aims to finalize them by November, with implementation by July 2023.
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