In an effort to reduce the student loan debt burden on millions of Americans, the Biden Administration recently launched a new income-driven repayment plan, known as the Savings on a Valuable Education (SAVE) plan. This is designed to lower the monthly amounts borrowers are required to pay and make it easier for many borrowers to eventually get their loans forgiven.
One thing the SAVE plan does not do is reduce or eliminate the interest rates on federal student loans. However, it does make one big interest-related change that borrowers need to know about.
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Student loan interest rates don’t change
When you take out a federal student loan, its interest rate is set for the life of the loan. The exact interest rate depends on the type of loan — Direct Undergraduate, Direct Graduate, or PLUS Loans — and the academic year you receive it.
For context, loans originated for the 2023-24 academic year have fixed interest rates of 5.5% for Direct Undergraduate loans, 7.05% for Direct Graduate loans, and 8.05% for PLUS Loans. And as mentioned, these are the same for as long as your loan has an outstanding balance. Even if you consolidate your loans, the rates don’t change — your new interest rate will simply be a weighted average of the interest rates on your existing loans.
One big interest-related change
Although the SAVE plan does nothing to eliminate or lower the interest rates for borrowers, it does make a big change to the way interest is applied.
You’ve probably heard student loan horror stories in the past that sound something like this:
“I took out a total of $75,000 worth of federal student loans to fund my bachelor’s and master’s degrees. I graduated 10 years ago and have been making student loan payments every month since then. And now I owe $90,000.”
The reason is that under income-driven repayment plans, the required monthly payment based on the borrower’s income isn’t enough to cover the interest that accumulates on the account. For example, if you owe $80,000 in student loans at an average interest rate of 6%, the interest on your loans accumulates at the rate of $400 per month. If you’re only required to pay $250 per month under your income-driven repayment plan, that leaves $150 in unpaid interest.
Under previous income-driven plans, including the popular PAYE and REPAYE plans, any unpaid interest was simply added to the principal balance. This is why some borrowers’ balances went up over time, even if they were making payments.
No federal student loan balance in repayment will go up with the SAVE plan
The SAVE plan fixes this problem by erasing any unpaid interest for borrowers who make their required payments. Even if your required monthly payment is $0, which will be the case for many borrowers under the SAVE plan, no interest will accumulate.
In short, no borrower enrolled in the SAVE plan who makes their required payments will see their student loan balance increase.
What else does the SAVE plan do?
In addition to the change to unpaid interest, the SAVE plan does a few other things to help borrowers. Just to name the highlights:
- Required payments on undergraduate loans are effectively cut in half, dropping from 10% to 5% of the borrower’s discretionary income.
- The definition of discretionary income is increasing from 150% to 225% of the federal poverty line, exempting more income from consideration. The Department of Education estimates this change alone will result in 1 million more borrowers with $0 required payments.
- Forgives any remaining balance after just 10 years in repayment for loans with original balances of $12,000 or less.
The bottom line is that the SAVE plan is the most borrower-friendly income-driven repayment plan offered to date. Borrowers who are currently enrolled in the REPAYE plan (the most popular existing plan) will be automatically enrolled, and for everyone else, enrollment is now open.
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