Biden's Education Department has a plan to prevent spiraling interest on student loans that can make it impossible for borrowers to touch the original balance they borrowed

• The Education Department unveiled a list of proposals to reform the student-loan industry.
• Preventing interest capitalization, which grows on a borrower's principal balance, is one of them.

Daniel Tapia, 41, got his bachelor's degree in dental hygiene over a decade ago. But his financial situation has been far from easy since then.

"I'm financially paralyzed by crippling debt and I can't get ahead in life," Tapia previously told Insider. "Murdered by the student-loan industry."

To afford the education for his degree, Tapia had to take out both private and federal student loans, and while he initially borrowed $60,000, his balance is now $86,000 and growing. That's thanks to interest on the debt that continued to add onto his principal balance, thus increasing the amount of debt that accrues in what feels like a never-ending spiral. It's keeping him from even touching the original amount he signed up to to borrow.

What Tapia experienced with his student loans is far from uncommon. Insider has spoken to over two dozen borrowers who reported the crushing student-debt burdens they have, largely caused by capitalization of interest. For some, it can be debilitating, keeping them in an endless cycle of repayment. For the duration of the pandemic, though, most federal borrowers have been relieved of surging interest thanks to the student-loan payment pause, which waived interest and is set to expire after August 31.

While President Joe Biden's Education Department has not yet confirmed whether another extension is on the books, it released a list of regulatory proposals it plans to tackle over the next year, including reforms to major student-loan-forgiveness programs, providing relief for students left with debt but no degree, and limiting interest capitalization — all of which will likely be implemented after Biden carries out broad student-loan forgiveness for federal borrowers.

"What I don't get is if I took out a certain amount, and I paid that amount already, and I still owe more than I originally owed, it's just nuts," Tapia said. "It's mind-boggling to me that this total amount is not going down. It's not going away."

Biden's proposal to tackle surging interest

Interest capitalization occurs when accrued interest is added to the original loan balance, and future interest grows based on that higher amount. That's something the Education Department is hoping to prevent, whenever possible, through its proposed regulations.

According to the department's 750-page preamble on the regulations, interest capitalization is most often spurred following periods of student-loan deferment or forbearance. The department is proposing to limit capitalization only to instances where it is specifically required within the Higher Education Act. The preamble says this would result in a loss of revenue since there would be fewer instances of capitalization, therefore increasing costs for the government and US taxpayers.

"However, the proposal is expected to result in lower total payments over time for borrowers, thereby increasing the likelihood that borrowers would repay their loans in full," the preamble says. "Given this benefit, the Department believes that the benefits for borrowers exceed these costs and justify the change."

The Higher Education Act states that interest capitalization can occur when a loan enters repayment, when a grace period expires, when deferment or forbearance periods expire, and when a borrower defaults. Currently, the department capitalizes unpaid interest annually during any period of negative amortization — in which a borrower fails to cover interest due on the loan — and it's seeking to end instances of capitalization that are permitted, but not required, under the Act.

Specifically, the department wants to remove:

• Interest capitalization on loans entering repayment following a grace period
• Interest capitalization on direct loans during forbearance periods
• Annual capitalization on unpaid interest when a borrower's income-contingent repayment plan doesn't cover accrued interest
• Interest capitalization on a defaulted loan

The department says it is not removing capitalization when it is required by statute, including when a borrower exits a deferment period on an unsubsidized loan, or when a borrower on an income-based repayment plan no longer has partial financial hardship.

In its explanation for proposing the rule, the department notes the "financial and psychological challenges" that accompany growing interest.

"The act of rolling unpaid interest into a borrower's principal balance can be a frustrating experience for borrowers who are confused as to what triggered the capitalization or surprised by the higher amount they owe because of capitalization," the preamble says. "Borrowers also frequently express frustration and surprise with interest capitalization, at least in part because this is not an occurrence they are likely to have experienced with other financial products."

The proposed rules will enter public comment for a 30-day period, and the department aims to finalize them by November, with implementation by July 2023.