Before We Talk About Student Debt Cancelation, Can We Talk About Interest Rates?

Case Example: PharmD Class of 2017 Interest Rate Reduction vs Debt Cancelation

Using the self-reported debt statistics from the 2017 AACP Graduating Student Survey, the mean principal loan at graduation answered by the 86% of students who reported borrowing money to pay for college was $163,494.⁵ If we assume that 86% number holds for all graduates and extrapolate to those who did not respond to the survey, then we can estimate just over $2B in total student debt for 12,466 students. Using the 10-year fixed standard repayment plan and 25-year fixed extended repayment plan, we can further estimate monthly payments per student and total interest paid over the full term at varying interest rates (Table 1). In this example, interest rates of 6% (current graduate debt average rates), 3% (lowest rate in current environment, and 1.5% (hypothetical rate half of lowest rates) were used to demonstrate the total costs of debt at each level.

For pharmacy graduates alone, eliminating all student debt for one single graduating class would cost more than $2B. Assuming that all loan servicers currently “break-even” at the 6% interest rate, the total gross margin that lenders would capture over 10- and 25-year repayment plans would be $677M and $1.9B, respectively. This means reducing the rates to 3% would “cost” $353M (the difference between revenue at 6% and 3%) over 10 years, or just $35.3M/year. Reducing the rates all the way to the level of inflation at 1.5% would cost $519M over 10 years, or just $51.9M/year. In other words, substantially lowering interest rates to 3% or 1.5% would cost the government a fraction of what total debt cancelation for pharmacy students in the Class of 2017 would cost.

When it comes to making “progress” in reducing the principal balance, the term and interest rates can have a major impact. At an interest rate of 6% and extended repayment term, the average student will be paying $1,053/month and will only see about a 10% reduction in principal after 5 years of routine payments (Table 1). Members of the Class of 2017 on this extended repayment plan can expect to have approximately 75% of their original principal balance when they receive an invitation to their 10-year pharmacy school reunion (Figure 1). This may cause some concern regarding the long-term impact of student debt on pharmacy school foundation fundraising and other alumni engagement activities. Decreasing student loan interest rates to inflation (∼1.5%) levels could reduce monthly payments, thereby freeing up discretionary income and allowing students to see more progress in reducing the principal balance.

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Figure 1.

Cumulative Percentage of Principal Paid by Month over 10 years (120 months) for 10- and 25-year Terms

Non-Pecuniary Reasons to Support Lower Rates over Debt Cancelation

One potential unintended consequence of debt cancelation may relate to the feelings of resentment generated between existing graduates that make up the alumni base for schools.⁴ For graduates who sacrificed various luxuries (leisure travel, conspicuous consumption, etc) in order to commit large proportions of discretionary income toward student loan principal payments, a sense of unfairness would likely arise. While these feelings may be mixed for many, it would be reasonable for those graduates to feel punished for actions that should be applauded.

As with most policy changes with financial implications, debt cancelation would shift incentives. In this case, current and future students may be inclined to borrow larger sums or take the maximum amounts rather than borrowing only the minimum required to cover tuition and costs of living. This may also slow down the work that some universities and organizations are doing to reduce the cost of college and become more efficient.

The mere discussion of debt cancelation may create an issue with present borrowers considering where to spend existing discretionary dollars. My wife and I currently have significant student debt balances from our undergraduate and professional school education. We also have long-term debt in the form of a mortgage for our home (which, has a lower interest rate than our existing student loans). Over the next 18-24 months, while this national policy debate and presidential election occurs, we are unsure whether it would be better to spend our discretionary dollars on paying off the student loans or the mortgage. Even though the mortgage has a lower interest rate, one could argue that the potential for student debt cancelation in 2020 is incentivizing us to simply pay the minimum on our student loans.

While debt forgiveness remains a priority issue for some voters, there is overwhelming public support for lower interest rates and increased grant funding for costs associated with college.¹¹ Even more surprisingly, non-Millennial voters are stronger supporters of lower interest rates than their Millennial counterparts.¹¹ While debt forgiveness can be extremely divisive politically, most can support bipartisan efforts to reduce interest rates for student loans. Lowering interest rates can still create incentive alignment issues as it would make student debt more favorable compared to other types of debt, but the debt would still remain as a disincentive.

CONCLUSION

The debate around student debt, especially for pharmacy educators, is complex and includes a wide range of objective and subjective factors.⁷ As with any topic discussed within campaigns during major election years, support for or against policy proposals that significantly change the way post-secondary education is financed in the United States will likely fall along political party lines. However, the math behind the debt itself should not be partisan. It is just math. As a graduate with student debt and an educator employed by a school currently creating more graduates with student debt, I hope we can put down our red and blue hats long enough to build consensus around a pragmatic solution to a growing problem.