Why lowering student loan interest rates isn't a game changer

Everyone knows student debt is growing. College costs are growing. Student debt delinquencies are rising. And now Hillary Clinton has her own plan for how to stem that tide of financial problems for college graduates.

On Monday, Clinton released a package of ideas aimed at helping Americans handle their college debt, which currently totals around $1.2 trillion. The package's splashiest proposal promises future students a debt-free four-year degree from a public school.

That could transform the higher education system of the future. But one other cornerstone of Clinton's plan aims to help people with loans right now — it involves lowering interest rates to help millions who are already out of college pay down their loans. The problem is that this sort of proposal may not help the borrowers who need the most help.

The basic idea behind Clinton's interest rate plan is simple: knock down interest rates to keep costs down for new borrowers, and let older borrowers who have been locked into higher interest rates for years refinance their rates lower.

Just a few years ago, for example, the interest rate on federal loans was 6.8 percent. Clinton's plan would allow current debtors to cut their interest rates to the current federal rate — 4.3 percent for undergraduate (subsidized and unsubsidized) loans, for example.

According to Clinton, that's great policy because it would save Americans lots of money.

"It is just wrong that people are locked into college loans at 8, 9, even 10 percent interest," she said in a Monday speech, adding that she wants to cut the interest rates such that the government makes no profit off of that interest.

She's not alone — Sen. Elizabeth Warren, D-Mass., has long been trumpeting the idea of lower interest rates on student debt. Cutting interest rates would save lots of people lots of money; the campaign estimates it would help 25 million people to the tune of $2,000 each, on average. But it doesn't benefit everyone the same. In fact, it would likely benefit higher earners more than a lot of struggling lower-earners, says one analyst.

"You're showering people with money who don't necessarily need it and are struggling in order to make the problem go away for people who actually need a bit of help," said Jason Delisle, director of the Federal Education Budget Project at the New America Foundation.

"It's not even clear it's an affordability problem. A lot of the non-repayment ... is happening on loans that are smaller than $9,000, where the monthly payment is about $100," Delisle said.

That means letting people refinance their student loan interest rates downward is a regressive policy — one that will naturally give the biggest dollar benefit to people with the biggest balances. A 1 percentage-point cut could save someone with a six-figure balance far more money than someone with a $5,000 balance.

And while a small share of truly struggling undergrads graduate with six-figure debt, a big chunk of people with that kind of debt are medical and law students. Around half of all medical and law students graduate with those levels, by one estimate. And those graduates also often end up in careers that make paying down that kind of debt a lot easier than for people in lower-paying fields. Not only that, but higher-income families tend to be far more likely to hold student debt than lower-income families, as the Brookings Institution found in 2014.

This is important because the student debt conversation is tied to a bigger macroeconomic conversation about millennials' failure to launch. One of the leading narratives in the student debt conversation is that high debt is helping to keep young adults from starting their own households. If people aren't buying houses, getting married and having children as a result of their student debt, that makes it all the more important to target the policy correctly.

The question is who is having the most trouble paying their loans down. Counterintuitively, it's the people who owe the least. The New York Fed examined student debtors in 2009 and found that delinquency rates decline as you move up the ladder of how much people owe.

Why are the lowest-owing people defaulting? The Fed's analysts hypothesized that these borrowers "may not have completed their schooling, or may have earned credentials with lower payoffs than a four-year college degree." People with less than four years of college tend to have lower wages and a higher unemployment rate than four-year graduates.

Also importantly, these are not equal-sized chunks of the population — the people in those bottom three groups of loan amounts accounted for two-thirds of borrowers. Very few people the Fed counted here owed huge balances, and those that did were also better at keeping up to date on their payments.

It's not that many high-owing borrowers wouldn't benefit greatly from a lower interest rate. Lots of them would. Rather, it's that there's only so much spending you can do on student debt relief.

"Refinancing is a great proposal in theory. It's hard to argue why we wouldn't want to do that," as Beth Akers, a fellow at the Brookings Institution told NPR's Tamara Keith, but she says it may not be the best way to fix the system. "We want to think, 'Is this really the most efficient or appropriate way to be spending taxpayer dollars?' I'd prefer to see those dollars be spent in shoring up the safety nets we have for existing borrowers."

With Clinton's plan costing an estimated $350 billion over 10 years, that raises the question of whether interest rates are the best place to spend a big part of that money.

For her part, Clinton does also want to make those safety nets Akers talks about easier to use. The current system of income-based loan repayment is a mess of programs — one called income-based repayment, but there are also income-contingent repayment and income-sensitive repayment to consider. Clinton's proposal would combine all these into one program that allows debtors to pay 10 percent of their income toward their loans and that would forgive remaining debt after 20 years.

This would be a big simplification, but it wouldn't be a sweeping change; a 10 percent payment cap and a 20-year forgiveness are already features of the existing Pay As You Earn plan. This would put everyone under that kind of plan.

Clinton said she wants to make it easier for delinquent or in-default borrowers to get into income-based repayment plans. According to DeLisle, robust income-based payment programs do more in helping the most struggling borrowers than interest rate cuts do.

This isn't the only student debt plan on the campaign trail; Clinton joins fellow Democratic candidates Martin O'Malley and Bernie Sanders, as well as Republican Marco Rubio. And these plans aren't just about the economy — they're good politics.

Consider that there were 23 million Americans with student debt as of 2004, according to the New York Fed. Today, there are around 43.3 million, growth of nearly 90 percent. That's a fast-growing group of voters to reach out to. And it's a group of voters who have already seen plans from farther-left politicians like Sanders and Warren. This proposal could help Clinton reach out to the young voters attracted to Warren and Sanders' ideas. Copyright 2019 NPR. To see more, visit https://www.npr.org.