Florida Senator Marco Rubio has introduced some genuinely innovative proposed legislation to address the student loan crisis.
The headline terms are 0% interest and streamlined Income-Driven Repayment. Both would be an improvement.
Unfortunately, the LOAN Act is likely to cause more issues than it fixes.
The Leveraging Opportunities for Americans Now (LOAN) Act Basics
Under the LOAN Act, new federal student loans would not charge interest. Instead, they charge a financing fee when the loan is first borrowed.
For undergraduate students, there is a one-time financing fee of 20%. For graduate students and parents, the financing fee jumps to 35%.
The default repayment plan is an income-based repayment plan that charges borrowers 10% of their discretionary income. However, borrowers would have the option of repayment on a standard 10-year repayment plan. Borrowers that quickly could have the financing fee partially refunded.
Notably, the income-based repayment is automatic. Borrowers wouldn’t have to apply each year manually.
The Problem with Rubio’s 0% Interest Loan
The idea of 0% interest usually sounds too good to be true. In this case, it is definitely too good to be true.
The massive “finance fees” mean borrowing money for school is still expensive.
For example, suppose you borrow $10,000 to pay for a year of graduate school. By borrowing that $10,000, you agree to repay the government a total of $13,500 (the original $10,000 plus the 35% financing fee).
How does this loan compare to a traditional loan that charges interest rather than massive fees? If you borrowed the same $10,000 for school and repaid the debt over ten years, that equates to a 6.3% interest rate.
The math gets complicated quickly, but the important takeaway is that there are still borrowing costs associated with these loans. Calling them 0% interest loans without this context is highly misleading.
The Biggest Issue with the LOAN Act
Rubio’s plan is a fascinating thought exercise.
In theory, it makes borrower costs far more straightforward. It also simplifies repayment.
The Rubio approach might make sense if we were designing a federal student loan system from scratch.
Unfortunately, we already have an extremely complicated system in place. We have too many loan types, too many servicers, too many repayment plans, and too many rules. Simplicity should be the goal.
The LOAN Act creates two significant complications to federal student loans.
- It makes a mess for current students. Rubio’s plan would mean that all new student loans were issued with hefty financing fees. How does a student who has two years of old loans and two years of new loans manage their debt? How do borrowers and servicers handle two completely different federal systems?
- It makes paying for college more confusing. If the LOAN Act becomes law, it would be difficult for students to compare federal loans against private loans. How does an 18-year-old student compare a private loan with a 0% interest loan with a massive financing fee?
Sherpa Thought: It is also worth noting that the LOAN Act wouldn’t actually do anything to fix the student loan crisis. It doesn’t lower college costs. At best, it only makes living with the debt more manageable.
Massive reform is a good idea, but any real changes will have to address the cost of school.
What the LOAN Act Gets Right
Federal law currently prevents the IRS from sharing income information with the Department of Education unless the borrower authorizes the disclosure. This rule is why borrowers must certify their income each year to stay enrolled in income-driven repayment plans.
Rubio’s plan to automate IDR enrollment has been discussed for years by members of both parties, but it hasn’t ever become law.
There is bipartisan support for automated IDR enrollment, and there isn’t a good argument against it. Hopefully, Congress can pass some legislation to address this fixable issue.
Does the LOAN Act Have Any Chance of Passing?
Rubio has introduced this proposed legislation on multiple occasions, and it has never passed.
Republican support for the bill seems very limited, and Democratic support appears nonexistent.
In other words, the LOAN Act is unlikely to become law, no matter how many 0% interest headlines you see.