Interest rates have had a small effect on the amount borrowed by graduate students, who were less restricted by borrowing limits than undergraduates. Higher rates were associated with a slight reduction in the amount of borrowing; lower rates were associated with a slight increase. For example, interest rates on student loans were lower during academic years 2014 to 2017 than they were from 2007 to 2013, slightly boosting graduate borrowing. Undergraduate borrowers did not appear to be sensitive to interest rates. After the borrowers’ and schools’ characteristics (such as the type or academic level of the school attended) were accounted for, higher monthly payments-which can result from higher interest rates-were associated with slightly higher rates of default.
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Repayment Plans. A borrower’s repayment plan, along with the amount borrowed and the interest rate, determines the monthly payment required on the loan. A variety of alternative repayment plans are available. Some of those plans extend the repayment period to 25 or 30 years; others, called income-driven repayment (IDR) plans, tie required payments to borrowers’ incomes and provide loan forgiveness after a certain period. In the first few years after borrowers enter repayment, the required payments under IDR plans are often too small to cover the interest that accrues on the loan, which contributed to rising levels of debt.
CBO found that repayment plans that lowered a borrower’s monthly payments tended to decrease the incidence of default. Because borrowers select repayment plans after deciding how much to borrow, CBO did not estimate the effects of repayment plans on the amount students borrowed.
Types of Loans and Repayment Plans
There have been two major federal student loan programs. The first was the Federal Family Education Loan program, which guaranteed loans issued by banks and nonprofit lenders from 1965 to 2010. In 1994, the Congress established the William D. Ford Federal Direct Loan program, which issued student loans directly with funds provided by the Treasury. The two programs operated in parallel through academic year 2010, either guaranteeing or issuing loans to students under nearly identical terms and offering a variety of loan types and repayment options. Federal student loans generally have terms that are more favorable to borrowers than loans offered by private lenders.
The Health Care and Education Reconciliation Act of 2010 eliminated new FFEL loans. In its last year, the FFEL program guaranteed 80 percent of the new loans disbursed and accounted for about 70 percent of total outstanding balances. Since then, all new federal student loans have been made through the direct loan program. 3 In 2020, direct loans accounted for about 80 percent of the outstanding loan balance.
Types of Loans
The direct loan program offers three types of loans: subsidized Stafford loans, unsubsidized Stafford loans, and PLUS loans. The loans vary by eligibility criteria, limits on the maximum size of the loans, and interest rates and rules about how interest accrues:
- Subsidized Stafford Loans. Available to undergraduate students with demonstrated financial need, subsidized Stafford loans have sometimes had lower interest rates than other types of loans. Most significantly, interest does not accrue on those loans during periods of schooling or when payments are deferred, for example, during periods of financial hardship or military service. The limits on how much students can borrow each academic year and for all their years of schooling are relatively low. In 2017, subsidized Stafford loans accounted for 23 percent of the total volume (in dollars) of all federal student loans disbursed and 38 percent of the total volume of federal student loans disbursed to undergraduates.
