By Ben Kaufman | August 6, 2021
A legal quirk is slated to lead millions of students taking on federal student loans over the next year to face billions of dollars of unnecessary added charges throughout repayment. There is nothing borrowers can do to prevent this on their own—but ED already has the power to stop it. ED must act now to stop borrowers from overpaying by billions of dollars, and policymakers at all levels must consider the key questions this situation raises about the structure of America’s student loan system.
Background: the formula for setting student loan rates
By law, federal student loan interest rates are set for each academic year using a formula based on the yield of the 10-year Treasury note auction from May of the preceding academic year. A fixed margin that varies for each type of Direct loan (undergraduate loans, graduate loans, and PLUS loans) is then added on top of that yield to determine each loan’s interest rate.
In simple terms, this means that federal student loan interest rates are set based on an arbitrary process that considers only an arcane bond yield rate and the date on the calendar—not the needs of students.
The 10-year Treasury note auction for May 2021 resulted in a 10-year Treasury rate of 1.68 percent. Accordingly, the interest rate on federal student loans for the 2021-2022 academic year will be 3.73 percent for Direct loans to undergraduates, 5.28 for Direct loans to grads, and 6.28 percent for Direct PLUS loans.
Rates in the Treasury market dropped after May 2021, but student loan rates are locked in
Here’s the problem: due in part to the worsening pandemic, the rise of the delta variant, and the market’s lack of confidence in the economy’s long-term prospects, rates on 10-year Treasury notes fell by almost a third after the May 2021 auction, even though Direct loan rates for the next year are already locked in. For the June auction, 10-year Treasury rates came in at 1.50 percent, down from 1.68 percent in May. Then, for the July auction, rates came in at 1.37 percent. And while the August auction is not scheduled to take place until next week, 10-year notes were traded in the secondary market for rates as low as 1.19 percent throughout July and August.
This small quirk in the law—that is, the specific timing of the mechanism used to set rates on Direct loans for the year—will have huge consequences for borrowers, as even minor differences in the interest rate on a student loan can lead to large added charges over a borrower’s entire loan term. Because borrowers will not be able to have their student loan interest rates be set at a time when prevailing rates on Treasuries happened to be lower, they will pay far more on those loans over time.
It is possible to estimate the scale of this effect. Information is limited, but during the last full academic year for which data are available 8,016,007 borrowers took on almost $90 billion in Direct loans, an amount equal to $11,225 per person. A roughly similar number of borrowers is likely to take on a comparable quantity of Direct loans during the current school year. Because these borrowers will pay an interest rate calculated using the 1.68 percent 10-year Treasury note base that arose in May instead of the 1.19 percent base that arose in July and August, these borrowers will face $2.5 billion more in added costs over a 10-year standard repayment term.
Those added costs include the following: 
- More than $1 billion in added cost for almost six million undergraduate borrowers;
- More than $784 million in added cost for 1.5 million graduate borrowers; and
- More than $696 million in added cost for nearly 700,000 parents.
Borrowers on IDR will face huge unnecessary accruals
The preceding analysis assumes that all borrowers will be in a ten-year “standard” repayment plan. Of course, this will not be the case. Roughly a third of Direct loan borrowers owing on almost half of all Direct loans currently utilize an income-driven repayment (IDR) plan. Under these plans, borrowers’ monthly bills are set as a percent of their income instead of being based on their outstanding balance and interest rate. Loans for borrowers in IDR are also forgiven after 20 to 25 years based on which plan borrowers use and which types of loans they have.
IDR is generous, but it involves a catch: for borrowers whose incomes are below certain levels, monthly payments may not be enough to cover the interest that continues to accrue on the loan, leading the borrower’s outstanding balance to grow over time. Even for those whose debts will one day be forgiven, simply having such a large and growing student loan balance has massive financial and emotional consequences. This is particularly true for borrowers whose incomes are so low that they qualify for a $0 monthly student loan “payment,” meaning that all of the interest their loans accrue is added to their balance each month.
For borrowers in IDR, the lack of an ability to benefit from the post-May drop in 10-year Treasury note rates will lead to massive extra interest accruals. Information on accruals in IDR is limited, but publicly available data and research make approximation possible. In particular, because these borrowers will accrue interest at a rate set using the 1.68 percent 10-year Treasury note base that arose in May instead of the 1.19 percent base that appeared in July and August, it is possible that low-income borrowers in IDR will face more than $320 million in added interest accruals over the next ten years.
Those costs include the following: 
- More than $234 million in added accruals for more than 559,000 undergraduate borrowers;
- More than $57 million in added accruals for more than 137,000 graduate borrowers; and
- More than $27 million in added accruals for more than 65,000 parents.
Moreover, we already know that the effects of runaway accrued interest such as the costs considered here are likely to land hardest on borrowers of color. Recent research indicates that roughly 75 percent of student loans being repaid in Black communities now exceed their original balance due to interest accruals, compared to only 51 percent of student loans being repaid in white communities. These disparities flow directly into massive racial gaps in repayment rates. For example, one study found that 12 years after entering undergraduate study, the median African American borrower owed 113 percent of his or her original student loan balance while the median white student owed just 47 percent of what he or she initially borrowed over the same time span.
ED already has the power to prevent borrowers from facing massive added costs—but it must act now
The HEROES Act of 2003 allows the Secretary of Education to waive or modify “any statutory or regulatory provision” applicable related to federal student aid programs “as the Secretary deems necessary in connection with a . . . national emergency.” This is the same authority that both the Trump and Biden administrations used to offer relief to federal student loan borrowers during the COVID-19 pandemic, including providing the basis for the ongoing zero-interest payment pause and the relief currently available for borrowers in default.
The Biden administration renewed the declaration of a national emergency related to COVID in February, meaning that Secretary Cardona continues to wield the substantial powers that the HEROES Act delegates to him in times of crisis. Secretary Cardona clearly maintains the power to permanently reduce the interest rate on federal student loans taken on during the current academic year—in fact, his ability to do so is likely the only thing that could prevent borrowers from facing the massive costs outlined above. And the clock is ticking. Borrowers have already begun taking on student loans for the current academic year, and interest on unsubsidized loans is already accruing.
More generally, this situation should prompt broader thinking by policymakers and the public regarding how we have decided to make Americans pay for higher education. Our country chooses to have a debt-based higher education system, to charge interest on those loans, and to set those interest rates using an arbitrary mechanism that has enormous financial ramifications for tens of millions of Americans. Quirks like the one described here—where market fluctuations following a capriciously selected date in the context of a worsening pandemic can lead to billions in added costs for people trying only to improve their lives—point to the broader absurdity of the current student loan system. And for borrowers, that absurdity comes with a hefty price.
Ben Kaufman is the Head of Investigations and a Senior Policy Advisor at the Student Borrower Protection Center. He joined SBPC from the Consumer Financial Protection Bureau where he worked as a Director’s Financial Analyst on issues related to student lending.
 SBPC calculations based on data from the Office of Federal Student Aid. Reflects the 2019-2020 academic year.
 These numbers reflect the 2019-2020 academic year, but they generally fit the trend of annual enrollment and can be taken here as illustrative of the magnitude of students likely to take on federal loans during the current school year and the amount that they will collectively borrow.
 Assumes that all borrowers utilize a standard, ten-year repayment plan. Due to data limitations, assumes that all graduate borrowers used only graduate Direct loans and not PLUS loans. Note that this assumption makes the overall calculation of added costs likely to be an underestimate, as rates on PLUS loans are much higher. For simplicity, ignores the effect of in-school accruals, though these accruals are likely to increase the scope of the added cost considered here.
 SBPC calculations based on data from the Office of Federal Student Aid.
 See CFPB, Data Point: Borrower Experiences on Income-Driven Repayment.
 As above, assumes the number of each type of borrower and starting average balance based on the 2019-2020 academic year. Assumes that 32.42 percent of borrowers are in IDR, based on the most recent data from the Office of Federal Student Aid. Assumes based on CFPB that 29 percent of borrowers on IDR have a 70 percent reduction of payments or more, and, based on estimations of monthly student loan payments based on prevailing interest rates and average balances, that all (and only) such borrowers negatively amortize. Assumes due to data limitations that all borrowers who negatively amortize are in $0 IDR. Assumes, following FSA, that half of interest accrued under REPAYE for unsubsidized loans is subsidized, that in addition all interest accrued under REPAYE for subsidized loans is subsidized for the first three years of repayment, and that payments on subsidized loans under PAYE and IBR are subsidized for the first 3 years of repayment. The proportion of borrowers in repayment in IDR on subsidized loans is assumed to reflect the rate of payment on subsidized loans across the student loan portfolio. Due to data limitations, caps on accruals are not considered here.