Borrowers’ student loan balances are growing over time. And it’s not just because of the interest rate.

Student loan interest rates will increase by slightly more than one percentage point for the 2022-2023 academic year for undergraduate and graduate students and parents borrowing to support their children’s education. A higher interest rate is a cause for concern because it makes accessing college more expensive for those who take out loans. And setting the interest rate and the cost of borrowing is and has long been a significant and often contentious topic of discussion. (The interest rate is set each year based on the sale of 10-year Treasury notes plus a markup and is fixed for the life of the loan. During the pandemic, payments are paused and interest has been set at 0% for most borrowers.)

But the interest rate alone isn’t what is causing the troubling growth of borrowers’ balances over the last decade. The growth is also due, in part, to several design elements of the student loan repayment system which can drive up the true cost of college after students have left school no matter the interest rate—and most often for those who can least afford it.

Negative Amortization

Income-driven repayment (IDR) plans are important tools—and contain critical protections—for borrowers. As the name suggests, these plans allow borrowers to make payments based on their incomes and family sizes, which can lower payment amounts for many and decrease the risk of default. To be clear, these payments may still be unaffordable for borrowers, especially for those with unpredictable incomes or high expenses that are not considered in the IDR payment-setting formula. But for some, payments can be as low as $0 per month.

But there is a catch: These lower payments may not cover the interest that accrues each month. The result is “negative amortization,” or balance growth over time, which can happen in the student loan system even as borrowers make regular payments. Many borrowers whose loans are negatively amortizing—a phenomenon that disproportionately affects borrowers of color—will pay more over the life of their loans.

Theoretically, these higher balances could be forgiven at the end of the 20-25 year IDR repayment period for some borrowers. But that forgiveness would likely come with a tax bill, and in reality, balance growth remains a barrier—both financial and psychological—for borrowers. The IDR system and its implementation are and have long been deeply flawed, making it hard for borrowers to enroll and remain in these plans from year to year and access the forgiveness promised at the end. (The Department of Education recently announced reforms to address some of these issues, but barriers—like a complex array of options; a confusing application process; and unclear, incorrect, or incomplete guidance—remain.)

While some IDR plans cover a portion of borrowers’ accruing, unpaid interest, the federal government should fully subsidize all unpaid, accrued interest over the life of the loan, which would disproportionately benefit those with low incomes relative to the size of their debt.

Interest Capitalization

A host of events and statuses—including exiting periods of paused payment, consolidating a loan, and not recertifying for an IDR plan—in the student loan repayment system trigger “interest capitalization,” when unpaid interest is added to a borrower’s principal balance and begins accruing interest itself. Capitalization makes balances grow more quickly and increases the amount that many will repay over time. The Department recently noted that interest capitalization “serves no purpose, other than to generate additional interest income” and is a source of confusion for borrowers.

Eliminating all interest capitalization events would simplify the repayment process and limit balance growth. The Department of Education has started that process by proposing to eliminate interest capitalization in all instances where it is directed via regulation, but legislative fixes are needed to remove the remaining requirements.

Interest Accrual in Default

Currently, interest continues to accrue on borrowers’ student loans even after they enter default, which is not typical for other consumer credit products. As a result, defaulted loan balances grow, and borrowers who are able to exit default can reenter repayment with much higher balances than when they started. This puts vulnerable borrowers—especially Black borrowers and other borrowers of color, those who leave school without a degree or credential, and first generation students, among others who are more likely to default—further behind.

The Department recently announced that it will allow those in default to reenter repayment in good standing after the current payment pause. It has also proposed that borrowers with defaulted loans be permitted to use IDR plans (as they currently cannot). But many fixes, including the removal of interest accrual, are still needed in a default system that can take borrowers’ means-tested federal benefits, garnish their wages, and charge high collection fees, leading many to pay more and more rapidly in default than they would if they were in good standing on their loans.

Interest accrual is, by far, not the only problem in the student loan repayment system. But negative amortization, capitalization, and the status of borrowers in default are often overlooked in conversations about the interest rate even though they can accelerate balance growth. Conversations around debt cancellation are moving forward, and forgiving balances would remove the debt burden (and resulting interest) for many. But, as an NPR article recently noted, the problematic underlying system remains inequitable and unchanged.