Making SRF Loans More Affordable Through Interest Rate Policies, Not Just Principal Forgiveness
State Revolving Fund (SRF) programs are among the most important financing mechanisms for water infrastructure projects across the United States. Through the Drinking Water (DW) and Clean Water (CW) SRF programs, states provide low-cost financing for essential water projects. These funds operate on a “revolving” model: loan repayments replenish the fund, allowing states to issue new loans year after year.
While making financing affordable is critical for communities in need, collecting interest on SRF loans is vital for the long-term durability of the funds. Principal Forgiveness (PF) is a key tool to expand access to SRF financing and make water infrastructure affordable, particularly for state-defined Disadvantaged Communities (DACs) facing significant barriers to water infrastructure investment. PF reduces the principal a borrower must repay, delivering immediate fiscal relief and lowering debt burdens.
While widely sought after by applicants, PF carries tradeoffs for the administration of a state’s SRF program. Every dollar forgiven is a dollar that does not return to the revolving fund, reducing future lending capacity unless states pursue replenishment strategies such as leveraging SRF assets through bond issuance—a strategy not all states currently use–or supplementing SRFs with additional state appropriations, a strategy adopted by even fewer states.
State administrators must therefore carefully weigh the benefits of PF against fund sustainability, and should consider alternative strategies such as lower interest rates for priority projects or applicants. This blog lays the groundwork for a deeper discussion at EPIC’s September 11 webinar on SRF loan terms and interest rate policy.
Lower Interest Rates Reduce Loan Burdens, While Still Revolving Dollars Back to the Fund
For state-defined DACs and other water systems facing affordability concerns, water infrastructure investments can be overwhelming. SRF loans can strain budgets and force water rate increases. PF can ease this burden by reducing repayment obligations. Lower interest rates are another way to reduce borrowers’ costs while ensuring the durability of state revolving funds. This is because low-interest loans, unlike principal forgiveness, return principal and interest back to the state revolving funds, helping current borrowers while replenishing the fund and ensuring it continues to support future projects. Even modest rate reductions can cut borrowing costs significantly. EPIC recommends that states consider tiered rates and fees tailored to applicant needs, striking a balance between affordability and program durability.
Reduced Interest Rates Can Provide as Much Loan Relief as Additional Principal Forgiveness
We compare three hypothetical scenarios of a $4 million SRF loan over a 30-year term, adjusting interest rates and the level of PF provided. The baseline interest rate of 2.5 percent is meant to reflect a typical SRF loan. EPIC’s interest rate policy brief provides a comprehensive overview of the various approaches states use to structure interest rates, fees, and other loan terms.
Using a standard amortization calculator, the scenarios below illustrate how SRF affordability is enhanced through principal forgiveness and reduced interest rates, respectively.
| Scenario 1 | Scenario 2 | Scenario 3 | Scenario 4 | |
|---|---|---|---|---|
| Loan Amount | $4,000,000 | $4,000,000 | $4,000,000 | $4,000,000 |
| Interest Rate | 2.5% | 2.5% | 1% | 1.5% |
| PF | - | 35% | - | 18% |
| Interest Owed | $1,689,741 | $1,098,332 | $969,731 | $795,179 |
| Total Debt Service | $5,689,741 | $3,698,332 | $4,631,609 | $4,075,179 |
In each scenario, the total debt service payments revolve back into the SRF. While some of these dollars may be needed to repay state-issued bonds, either for providing state matching funds for federal capitalization grants or leveraging the fund, the majority will remain available to finance future water infrastructure projects.
These scenarios illustrate how both PF and reduced interest rates reduce repayment obligations and highlight that interest rate reductions can, in some cases, provide equal or greater relief.
In Scenario 1, a $4 million loan at 2.5 percent yields approximately $1.7 million in interest over the loan term, with total debt service of $5.7 million ($1.7 million interest plus the full $4 million principal).
Scenario 2 applies 35 percent PF, reducing the principal by $1.4 million, which lowers cumulative interest to $1.1 million and total debt service to $3.7 million. While some states may offer more generous PF, a 35 percent reduction - $1.4 million in this case - represents a typical cap for principal forgiveness. Compared to Scenario 1, this offering results in nearly $2 million in savings over the loan term.
Scenario 3 demonstrates that reducing the interest rate by 150 basis points (from 2.5 percent to 1 percent) lowers total debt service to $4.6 million, about half the savings achieved under Scenario 2 with PF. This scenario illustrates that interest rate reductions can substantially ease debt service obligations, though generally not to the same extent as sizable PF allocations.
Scenario 4 illustrates a hybrid approach combining PF and interest rate reduction. With PF reduced by half (35 percent to 18 percent) and the interest rate reduced by 100 basis points (from 2.5 percent to 1.5 percent), total debt service over the 30-year term comes to just under $4.1 million. Notably, this repayment option is nearly equivalent to the $4 million principal, leaving only a $400,000 difference compared to the maximum PF scenario. Spread over the 30-year term, that difference translates to roughly $13,000 in additional annual debt service, or just over $1,000 per month. For a single loan, $400,000 in additional repayment revenue may appear modest from the perspective of the SRF as a whole. However, if this level of repayment is realized across ten loans per year, it yields an additional $4 million returned to the SRF each year. It is equivalent to financing roughly one additional loan of this size per funding cycle.
Image 1: Amount of debt service by scenario
From a policy perspective, this comparison demonstrates that targeted interest rate reductions can deliver affordability benefits comparable to PF while preserving the revolving capacity of the loan fund to the same degree. PF will remain an important affordability tool. Indeed, federal law requires states to allocate a portion of their SRF federal capitalization grants as PF or other subsidies, as explained further in EPIC’s SRF Brief on PF Policies.
PF may also be especially important for borrowers concerned about their credit rating. Such communities often prefer PF over interest rate reductions, even when the savings are similar, because PF directly lowers the total debt liability recorded on a utility’s books. For utilities with already significant debt obligations, reducing the principal on new loans can strengthen their credit positions by lowering overall debt burdens. However, the availability of PF will always be limited.
Targeted interest rate discounts provide another important tool to make SRF financing more affordable for those who would otherwise struggle to repay SRF loans. While there will be parameters around the extent to which states can reduce interest rates and still maintain the durability of their funds, states may have more flexibility to extend interest rate discounts to a wider set of borrowers. Interest rate reductions might be offered more expansively than PF, as an additional benefit for those receiving PF and to make loans more affordable for borrowers–particularly state-defined DACs–who do not receive any PF. Several states provide zero-interest loans for lead service line projects, and Ohio offers zero percent interest on SRF loans for all state-defined DACs as well as for regionalization projects. A key strength of SRF programs is their flexibility, which allows state administrators to tailor financing terms to better meet borrowers’ needs.
Moreover, even with reduced interest rates, principal and interest repayments preserve the fund’s capital base and allow states to recycle dollars into additional projects. This underscores the importance of interest rate policy design as a tool that balances borrower affordability with the long-term sustainability of SRFs.
Conclusion: A Balancing Act Worth Exploring
While the scenario analysis above cannot capture the full range of policy considerations, it reflects practices some states already employ, such as offering heavily discounted interest rates to state-defined DACs and other priority applicants and projects. Ultimately, the decisions SRF administrators make on interest rates, fees, and related loan policies play a critical role in determining whether utilities and municipalities—particularly those serving disadvantaged communities or facing affordability challenges —are willing and able to access SRF financing.
We will explore these issues further in an upcoming SRF webinar on September 11, 2025, from 2–3 p.m. ET. This event is the first in a three-part SRF webinar series. Register here. Additional details are available here.
