Prior to the student loan repayment changes -- when could an individual wind up being charged more in interest than their minimum payments?

Question

When I had student loans I was able to make minimum payments on mygreatlakes (the website I was directed to go to after graduating). I have some recollection about these being special loans with extra protections; I know I had to fill out a fafsa form every semester in order to get the loans, and I think the interest was fixed at some low number, maybe 3% but it's been a decade or two since I thought about the loans any further than "I need to make this payment"

I didn't go about refinancing because I had heard horror stories about variable interest; I also didn't need to look into an income based repayment because I was fortunate enough to be able afford to make payments. I also recognize that my loans were under a special program, presumably with lots of extra regulation -- it was explained to me when I applied that since my education wasn't like a car or a house (something that could be repo'd), the student loan issuers wanted to ensure that I had the best change of paying it off.

With the news about student debt relief, I'm hearing about people who were making payments reliably and having their balance either barely move or even increase in value. I'm not discounting the veracity of these stories, just asking how things like this occurred -- I know the general rule of credit is to set minimum payments so that they would cover at the very least the interest and a few pennies of the principal.

Also, how does the changes packaged with the $10,000 relief changed this? Is it still possible for the balance to go up when making payments?

TL;DR -- How could a student loan balance go up instead of down if the debtor was making consistent minimum payments, also is this still possible under the recent changes from the Biden admin?

Answer 1

I know the general rule of credit is to set minimum payments so that they would cover at the very least the interest and a few pennies of the principal.

Some lenders set minimum payments that DO NOT cover even the current interest. Since student loan debt can't be discharged in bankruptcy, this isn't as dangerous to the lender as you might think. For example, Discover offers student loans with a flat $50/month minimum payment. If you owe $24,000 at 3% you'd need to make a $60 monthly payment to just pay off the interest for the month, so making the minimum monthly payment, you'd be adding $10 a month to your debt. Obviously this gets worse if you owe more or are paying a higher interest rate.

Answer 2

How could a student loan balance go up instead of down if the debtor was making consistent minimum payments

There's absolutely no guarantee that the minimum payment covers all the accrued interest. You'll need to look at your specific loans and payments to know what happens in your personal case, but the general assumption you've made that by making the minimum payment you will necessarily pay off any loan is incorrect.

is this still possible under the recent changes from the Biden admin

The proposed program doesn't change how interest works, it only changes the balances on which it accrues. I believe the proposal is to reduce the balances by 10-20K for certain people who qualify.

For some borrowers who are on income-driven repayment plan, the proposal is to cover the unpaid accrued interest. In that case the loan balance will in fact stop growing if the borrower makes the minimum payments, but it will also not go down since the government will only pay the remaining unpaid interest (which is now being added to the principal).

Answer 3

The lender sets the minimum payment, and there are no laws or regulations that I am aware of that require it to be more than the interest accrued. As to why a lender would set such a low minimum, it's possible that they set them low enough so that you accrue (and compound) additional interest, making them more money in the long run. That would be low risk to the bank for at least three reasons:

1. A lower minimum payment reduces the change that a lender decides to skip payments, getting the bank at least some money
2. Federal loans are guaranteed by the federal government (no risk of default)
3. Federal student loans are not able to be dismissed in bankruptcy

Answer 4

If someone is paying on income based repayment, they do not have to pay even the interest each month.

Income based repayment caps your payment at 5% of discretionary income, which means the government subtracts whatever the poverty line * 1.50 is in your state and charges 5% of what's left over.

If you have a family and only make 40k a year, that number probably isn't very high. Depending on your interest rate, 5% of whatever is above the poverty line won't even cover interest - hence your loan balance increases.

If my understanding from new coverage is correct, for federal loans, the government will ensure the balance doesn't increase by paying the difference in interest. So it won't go up but will never go down either.

Answer 5

The income-based repayment plans currently cap the monthly payments at a percentage of an individual's discretionary income (between 10 and 20%). If you have $100k of loans at 5% interest but have an adjusted gross income of less than $40k then your income-based repayment likely wouldn't cover the interest on the loan and the balance would increase.

Rates can often be higher than that, and even if you're not on an income-based repayment plan you could work out a minimum payment with the lender that results in increasing balance.

Under the proposed plan, the max payment would be 5% of discretionary income and the government would make up the difference between the minimum payment and the accrued interest if there was a shortfall to make it so balances do not go up. So it is possible that under the proposed plan someone could have a balance that stays the same for 10-20 years despite making payments.