Accrued Interest

March 22nd, 2013 / By Deborah J. Merritt

Earlier this week, a student forwarded an email that he received from his federal loan servicer. After a perky “Hi,” the email reminded the student that interest accrues every day on unsubsidized educational loans. The email then spelled out his personal liability: He’s accruing $21.79 per day in interest. As he studies for his final law school exams, celebrates on graduation day, studies for the bar, and searches for a job, interest will accrue seven days a week. By November 1, when he hopes to have received good news of bar admission and obtained a job, he’ll owe another $4,881 for his law school education–just from interest accrued after today.

This student’s experience is not unusual. In fact, the interest gathering daily on his loan is lower than the interest accrued by many students. This student is an in-state resident at a public law school, and he received a three-year partial scholarship. During his first two years of law school, Congress subsidized some of his loans (meaning that interest did not accrue). Congress revoked that benefit for professional students last July, so 1Ls and 2Ls are gathering more interest than this 3L did. The interest does not compound until six months after graduation, but it accrues every day.

Paying jobs have declined during law school, and many students feel pressure to complete unpaid internships during the summer and academic term. Those factors, combined with rising tuition and living expenses, push law school loans ever higher. The interest rates on those loans, furthermore, are steep: 6.8% for the first $20,500 borrowed each academic year and 7.9% on anything above that amount. At those rates, daily interest charges mount quickly.

ABA and media reports about “average law school debt” don’t include this accrued interest. Law schools report only the amounts that their students borrow, not the full debt at graduation. The accruing interest falls through the gap because schools process only the initial loans, they do not handle interest charges or debt collection. This unfortunate circumstance means that both the borrowers and the schools may overlook the interest gathering daily.

Concern about that neglect seems to have motivated the email my correspondent received. The loan servicer wanted him to remember that interest was accruing daily on his loan, and that he could save money by paying the interest now. But how is a borrower supposed to pay interest while still collecting the loan? Should he borrow additional funds to service the interest? If funds were available at a lower interest rate, he would have tapped them before the student loan. The message suggests that students are partying with their money rather than studying for finals, worrying about the bar exam, and searching for jobs. For a law student, this type of message just ratchets up the anxiety.

I think it would be better to send these messages to law faculty. Imagine opening an email that read: “Hi! 185 of the third-year students in your law school have loans supporting their education. We want to remind you that these loans accrue interest daily. At your school, the average amount of daily interest is $21.79 per student. That’s $4,031 in interest accruing daily in your third-year classrooms. Accrued interest between now and graduation will exceed $200,000 for your class. Between now and August 1, when these students finish the bar, the collective total will be just over $536,000. That doesn’t include principal or interest accrued earlier in law school. Have a nice day.”

The messages, of course, could be customized by school. Average accrued interest and number of indebted students would vary. For some schools, the numbers would be lower. For many, especially large private schools, they would be much higher.

None of that accrued interest will come to law schools. Nor will it benefit the clients our graduates hope to serve. Interest payments support the work of loan servicers, including the profits they realize. They also compensate the government for the lost use of the loan money, forgiven loans, and defaulted loans. What a waste of our graduates’ assets. Our costly education programs require our students, not only to pay our hefty fees, but to shoulder high-rate interest that accrues daily.

It’s sobering to think how much interest accrues on student loans during each day that we teach, hand out exams, grade, or watch our students claim their diplomas.