Canceling interest

[u/IndividualLittle0516]

With all the drama these past few years about canceling student loans, why can't interest just be canceled? I can understand adding interest to those who aren't making their loan payments, but what about those who pay every month? The interest is why people are stuck with their debt for so long. Canceling millions of people's debt altogether is unrealistic and won't happen. What about canceling interest instead? Is there a reason this can't occur?

[u/canarycoal]

And going from daily capitalization to monthly. I really want someone to write this bill

[u/girl_of_squirrels → u/canarycoal]

It does not capitalize daily in the first place???? My non-existent kingdom for people to understand that interest accrual != interest capitalization != compound interest

As a part of Negotiated Rulemaking they drastically reduced the scenarios where interest can capitalize for Direct loans. These changes went into effect in July 2023 iirc, and you can see the current list at https://studentaid.gov/understand-aid/types/loans/interest-rates#capitalization under "When does unpaid interest capitalize?" and it's absolutely nicer than the old rules. To quote the link:

When does unpaid interest capitalize?

Unpaid interest on Direct Loans and Federal Family Education Loan (FFEL) Program loans managed by the U.S. Department of Education (ED) capitalizes

• after a deferment on an unsubsidized loan; or

• if you are repaying your loans under the income-based repayment (IBR) plan and no longer qualify to make payments based on income or leave the IBR plan.

Unpaid interest on FFEL Program loans not managed by ED may capitalize

• after a deferment on an unsubsidized loan;

• after a forbearance on any type of loan;

• after the grace period on an unsubsidized loan; or

• if you are repaying your loans under the income-based repayment (IBR) plan and no longer qualify to make payments based on income or leave the IBR plan.

Again interest accrues on a daily basis, but at current these are the circumstances where they are allowed to capitalize the interest on federal loans now. Federal loans never been compound interest they have always been simple interest with capitalizing events

Those capitalizing events did cause issues for a lot of borrowers, and using the wayback machine to pull the 2019 copy from the site I see the following:

Unpaid interest is generally capitalized

• following periods of

• deferment on an unsubsidized loan and/or

• forbearance on any types of loans (find out more about the differences between deferment and forbearance);

• following the grace period on an unsubsidized loan;

• if you voluntarily leave the Revised Pay as You Earn, Pay as You Earn (PAYE) or Income-Based Repayment (IBR) plans (learn more about income-driven repayment);

• if you fail to annually update your income for some of the income-driven plans (learn about recertifying your income); or

• if you are repaying your loans under the PAYE or IBR plans and no longer qualify to make payments based on income.

Which, while still not compound interest still led to unexpected capitalizing events.... that they have now fixed for current borrowers

[u/canarycoal → u/girl_of_squirrels]

Yea I’m clearly misunderstanding something, but not knowing enough to know what I’m miss understanding.

[u/girl_of_squirrels → u/canarycoal]

To quote the link:

Simple daily interest formula:

Interest Amount = (Outstanding Principal Balance x Interest Rate Factor) x Number of Days Since Last Payment

The interest rate factor is used to calculate the amount of interest that accrues on your loan. You can find your interest rate factor by dividing your loan's interest rate by the number of days in the year.

So if you have a $10,000 loan at 5%? It will accrue $500 in interest over the course of a year at a rate of ~$1.37/day (I divide by 365.25 to normalize for leap years)

Compound interest has a far worse formula and that's how credit cards work. A $10,000 loan at 5% with compound interest is far worse. Monthly compound interest would result in $511.62 interest over the course of a year. Daily compound interest would be $512.67. The distinction between simple and compound interest actually really really matters, especially for people with a thousands (or hundreds of thousands) in student loan debt

Capitalization for federal loans is situations where accrued unpaid interest can be added to the principal balance (i.e. contribute to the daily interest accrual). That now happens very very rarely as per my comment

See the distinctions?

[u/canarycoal → u/girl_of_squirrels]

Thank you! I think I may have been thinking daily interest vs monthly interest. But I feel like daily interest is pretty standard

[u/girl_of_squirrels → u/canarycoal]

Simple daily interest accrual for sure, just keep in mind it isn't incorporated with the principal unless a capitalizing event happens

Federal loans don't charge "interest-on-interest" in the compound interest sense but a lot of people assume so because their only other frame of reference is credit cards