Senate bill proposes no-interest federal student loans: What you need to know

While lawmakers debate the best way to handle the student loan debt crisis, Sen. Marco Rubio, R-FL, has reintroduced a bill that would change the way students pay for federal direct student loans.

Under the Leveraging Opportunities for Americans Now (LOAN) Act, federal loan borrowers would pay a one-time financing fee instead of interest. But depending on the type of loan, the fee may be equivalent to up to 35% of the principal amount:

• Federal direct loans: 20%
• Graudate student loans: 35%
• Parent PLUS loans: 35%

Keep reading for a cost comparison of the proposed no-interest student loans versus the current interest-based federal loans, as well as more about your alternative college financing options, including private student loans.

If you decide to supplement your higher education costs with private student loans, you can compare interest rates across multiple lenders on Credible without impacting your credit score.

BIDEN ADMINISTRATION ISSUES 'FINAL EXTENSION' OF STUDENT LOAN PAYMENT PAUSE: IS CANCELLATION NEXT?

One-time financing fees vs. interest: What's the better deal?

The cost of a one-time fee on federal student loans, per the LOAN Act, ends up being fairly equivalent to what current borrowers might pay in interest. The financing fees proposed by the bill may seem steep at up to 35%, but interest charges can add up quickly, especially for federal student loan borrowers who don't adhere to their repayment plans.

"My bill would reform our federal student loan system so that borrowers don’t get stuck with debt they can never repay," Sen. Rubio said in an Aug. 4 statement. 

The benefit of a no-interest loan is that the amount borrowers pay would be capped, whereas interest can become problematic for borrowers who are in default or forbearance for long periods of time. 

Let's say a borrower takes out $40,000 worth of federal direct loans at the current interest rate of 3.73%, according to the Department of Education. If they were to repay their student loans over the course of 10 years, their student loan payments would average $400 a month and they would pay $7,984 worth of interest.

But if the same borrower took 15 years to fully repay their loans, and had interest accrue while their loans were in forbearance, they could pay more than $12,000 in interest over the life of the loan. You can use Credible's student loan calculator to see how much interest you would pay over time.

98% OF PUBLIC SERVICE LOAN FORGIVENESS APPLICATIONS REJECTED

Under the LOAN Act, the 20% one-time fee on a $40,000 federal undergraduate loan would equate to $8,000. But the fee could potentially be discounted based on the borrower's annual income:

• Less than $45,000: Up to 15 percentage points
• From $45,000 to $95,000: Up to 10 percentage points
• Greater than $95,000: Up to 5 percentage points

Borrowers would automatically be enrolled in an income-based repayment (IBR) plan and those making 150% of the federal poverty level (FPL) or less would not have to make loan payments while their income remained at this level, the bill says. 

To reduce financing costs, borrowers would have the option to pay extra toward their loan — similarly to how a borrower might consider paying their loans early to reduce interest costs under the current student loan financing system. 

For graduate student loans and parent PLUS loans, borrowers would pay a financing fee of up to 35%. This is quite a significant difference from the undergraduate loans, but consider that current student loan interest rates for these types are also much higher at 5.28% and 6.28%, respectively. 

In contrast, the interest rates on private student loans can be much lower — particularly when compared with PLUS loans. You can browse private student loan interest rates from real lenders in Credible's table below to see how different rates can impact the cost of borrowing.

WHY YOU SHOULD KEEP PAYING YOUR FEDERAL STUDENT LOANS DESPITE COVID-19 EMERGENCY RELIEF MEASURES

Federal vs. private student loans for financing your education

The LOANS Act is in the early stages of just being introduced to the Senate, and it would have a long way to go before being passed and enacted into law. In fact, this is the second time the legislation has been introduced to Congress — it was first brought before the Senate in May 2019.

Borrowers who are looking at ways to pay for college now wouldn't need to worry about the LOAN Act. They instead should consider the choices that are available to them for the 2021-22 school year: federal and private student loans.

Federal student loans come with protections and benefits that make them a good first choice when students are looking for ways to finance their college education. It's smart to start by filling out the Free Application for Federal Student Aid (FAFSA) to see what kind of grants and loans you're eligible for.

BIDEN LAUNCHES INQUIRY TO FIX FAILED PSLF PROGRAM

Private student loans can be a useful tool when you're looking for ways to pay for education-related expenses when federal loans don't cover the full cost of college. Private loans don't come with the same federal protections like deferment, forbearance and income-driven repayment (IDR). However, private student loans may come with more competitive interest rates, which can make them an affordable borrowing option.

Private student loan interest rates vary depending on the loan amount and length, as well as your credit score. So if you're considering borrowing private student loans, make sure to shop around for the lowest possible interest rate for your situation. 

Interest rates on private loans are holding steady near record lows, making it a favorable time to borrow private loans. You can compare rates across multiple private lenders at once by filling out a single form on Credible.

ANOTHER STUDENT LOAN SERVICER ENDS FEDERAL CONTRACTS — ARE YOU IMPACTED?

Have a finance-related question, but don't know who to ask? Email The Credible Money Expert at moneyexpert@credible.com and your question might be answered by Credible in our Money Expert column.