Simple Fixes for Income-Driven Repayment

Income-driven repayment plans are a crucial safety net for student loan borrowers, but they include well-known design flaws. Jessica Thompson and Michele Streeter write about bipartisan solutions to improve the plans.

February 20, 2020
 
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Last week, the Congressional Budget Office released a report projecting that subsidies for federal student loan borrowers enrolled in income-driven repayment plans will cost the federal government $82.9 billion over the next decade. This number grabbed headlines -- as did CBO’s projection that borrowers who took out loans to attend graduate school account for significantly more of the cost than do borrowers with only a bachelor's degree or less.

Senator Lamar Alexander, the Tennessee Republican who chairs the Senate’s education committee, and Senator Mike Enzi, the Wyoming Republican and chair of the budget committee, have expressed concerns about the budgetary impact of IDR and commissioned the CBO report. The report illustrates both the vital role of IDR for borrowers as well as the need to better target its benefits to those who need them most.

IDR plans have long enjoyed bipartisan support for their role in helping borrowers avoid default and stay current on their payments, even when their incomes are low. But some current IDR plans, which allow a borrower to make monthly student loan payments based on a percentage of their income, include several well-known design flaws that mean higher-income, high-debt borrowers can receive outsize benefits.

Luckily, there is widespread, bipartisan agreement on both the need to address these issues and on how to address them -- an encouraging area of bipartisan overlap in an increasingly polarized higher education policy environment.

These recommendations to better target the benefits of IDR are one component of our broader recommendations for improving IDR -- including making it available to all borrowers, streamlining existing plans into a single one that caps monthly payments at 10 percent of income and provides tax-free forgiveness of any remaining debt after 20 years of payments, and taking measures to restrain ballooning balances for borrowers with low incomes relative to their debt.

A Crucial Safety Net

With all attention on the cost estimates, another of CBO’s key findings went largely unnoticed: borrowers in IDR are about half as likely to default on their loans as borrowers who are not in IDR. This confirms prior research that IDR -- which acts as a critical safety net for borrowers who may be struggling to make monthly payments, whether for a short period or over many years -- is highly effective in keeping borrowers out of delinquency and default.

Household incomes and grant aid have not kept pace with the rising cost of college, and most students borrow to finance their education. Federal student loans are the safest form of student debt, in part because they offer the unique protection of income-driven repayment options that base a borrower’s monthly payment on a set percentage of their income rather than on a set amortization schedule.

While IDR is not a solution to rising college costs, it helps borrowers avoid default and stay current on their payments. And for borrowers who have low incomes over a long period of time, it provides a light at the end of the repayment tunnel -- any debt remaining after 20 to 25 years of payments (depending on the plan) is forgiven. (This forgiveness, however, is hardly a windfall, as it is currently treated as taxable income.)

Bipartisan Calls for Three Targeted Fixes

In response to CBO’s report, Enzi called for lawmakers to “ensure they are targeting limited federal resources appropriately.” The report also came a few days after the president’s fiscal year 2021 budget request, which included proposals to cut back on IDR subsidies, especially for graduate borrowers.

But Republicans are not the only ones calling for targeted fixes to IDR. The REPAYE IDR plan created by the Obama administration in 2015 made changes that address CBO’s concerns. House Democrats’ most recent proposal to reauthorize the Higher Education Act included measures to better target IDR to the neediest borrowers. And a proposal introduced in 2019 by Senate Democrats includes similar targeting proposals. These proposals all reflect TICAS’s long-standing recommendations for improving IDR.

Below are three widely agreed-upon changes that would target the benefits of IDR to borrowers who need help the most -- and prevent borrowers with higher incomes and high debt from receiving loan forgiveness when they could have afforded to pay more.

Fix No. 1: All borrowers in IDR should always make payments based on their income.

The way monthly payments are calculated in several existing IDR plans results in some higher-income borrowers paying a smaller share of their income than lower-income borrowers do.

This so-called standard payment cap limits a borrower’s monthly payment in an IDR plan to the amount they would have paid if they elected to pay on a 10-year standard repayment plan.

For example, in one IDR plan, a borrower with $30,000 in debt would pay 10 percent of her discretionary income if she earned $35,000 a year, but only five percent of her discretionary income if she earned $100,000 a year. This is because the standard payment cap would limit her payment to $345 per month. If set at 10 percent of her discretionary income, the monthly payment would be $683 per month, based on an income of $100,000.

Requiring higher-income borrowers to pay the same share of their income as lower-income borrowers, as the REPAYE plan does, will make IDR fairer and more targeted.

Fix No. 2: Gradually phase out the income exclusion for higher-income borrowers.

Currently, a portion of a borrower’s income is excluded from consideration when their monthly IDR payment is calculated. This design detail (often referred to as an “income exclusion”) rightly recognizes that borrowers need to cover necessities like housing, food and transportation before being required to make payments toward their student loans.

For low-income borrowers struggling to make ends meet, an income exclusion of 150 percent of the federal poverty level for their family size may even be too low to account fully for necessities. However, whether it remains the same or is raised, higher-income borrowers can reasonably be expected to put a larger share of their total income toward loan payments and still have enough funds left to cover necessities. For that reason, we and others have recommended phasing the income exclusion out for high-income borrowers.

Fix No. 3: Treat married borrowers consistently, regardless of how they file their taxes.

In some existing IDR plans, married borrowers who file their taxes separately can enjoy lower monthly loan payments than those who file jointly. This means that in some IDR plans, a married borrower with low individual earnings who files taxes separately could have very low or even $0 monthly payments, even if their spouse is a high earner and their joint finances would support higher monthly payments.

Requiring consistent payment calculations for all borrowers would further ensure that those who can afford to pay more are not receiving subsidies that should go to needier borrowers.

It’s also important to note that in implementing this change, there should be an exception for borrowers who are separated from their spouse or cannot reasonably access their spouse’s income information (e.g., in cases of domestic violence).

Keep What Works and Tweak the Rest

As CBO showed in its attention-getting report, income-driven repayment is a critical safety net for lower-income borrowers, but it also provides overly generous subsidies to many higher-income borrowers.

There is bipartisan agreement on the need to ensure that the neediest borrowers are receiving the most help. It’s now up to policy makers to implement these reasonable proposals.

Bio

Jessica Thompson is an associate vice president for the Institute for College Access and Success (TICAS). Michele Streeter is an external affairs and policy analyst for the group.

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