Department of Education Eliminates Most Instances of Interest Capitalization, But More Progress Is Needed

Additional reforms could help limit the negative effects of balance growth for borrowers

DOE Eliminates Most Instances of Interest Capitalization

On July 13, the U.S. Department of Education published a Notice of Proposed Rulemaking (NPRM) on several issues pertaining to college affordability and student loans. The NPRM includes a proposed rule that would eliminate all instances of student loan interest capitalization not required by statute. The Pew Charitable Trusts provided comment on this proposed rule, commending the department for taking an important step to slow the growth of student loan balances while encouraging it to go further in future rule-making on income-driven repayment (IDR) plans.

Pew’s comment notes that the department’s proposed rule is supported by Pew research, also cited in the NPRM, that has found that interest accrual and capitalization can result in significant balance growth for struggling borrowers, especially for those enrolled in IDR plans. Interest capitalization often imposes a penalty on borrowers who are already experiencing financial instability and have reached out for tools created to help them, such as IDR and forbearance.

In the comment, Pew urges the department to enact additional policies to address balance growth through interest accrual in IDR plans. Pew research demonstrates that balance growth can cause negative psychological impacts for borrowers, discouraging repayment. The comment includes policies for the department to consider in order to control balance growth, such as:

  • Expanding interest subsidies. In addition to subsidizing the unpaid interest of borrowers who make $0 payments, as outlined in a plan previously proposed by the department, future IDR plans should expand interest subsidies to payments above this amount.
  • Enhancing payment tracking. The Government Accountability Office recently identified significant problems with the process of counting qualifying payments, which are required to verify eligibility for loan forgiveness under the current suite of IDR plans. To address the psychological burdens of long-term balance growth, the department may consider proposals such as accelerating time to forgiveness of loan balances for borrowers classified as “low income” as well as incremental forgiveness, which would regularly forgive a portion of borrowers’ balances at shorter intervals—perhaps as an incentive for making a certain number of payments.
  • Implementing the Fostering Undergraduate Talent by Unlocking Resources for Education (FUTURE) Act. The department can take steps beyond the regulatory process to help borrowers be more successful in repayment. Although the department’s proposed rule on interest capitalization would eliminate such capitalization events when a borrower exits most IDR plans, issues with recertifying IDR plan enrollment can still cause problems for borrowers. The FUTURE Act, passed by Congress and signed into law by the president in 2019, will help eliminate this friction point for borrowers once it’s fully implemented by the department. 

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