UNDERSTANDING STUDENT DEBT

REPAYMENT PLANS

The federal government has a complicated and confusing system for loan repayment. Borrowers who do not make an active choice are placed in a standard repayment plan where they make equal payments over 10 years to retire their entire debt. But there are multiple additional options that can dramatically reduce monthly payments for many borrowers and, in some cases, lead to remaining balances being forgiven after 10, 20, or 25 years.

One-third of borrowers – owing almost half of the outstanding debt – are enrolled in income-driven repayment plans, which set their monthly payments at an affordable share of borrowers’ current incomes.

The details of the IDR plans vary, but borrowers generally make no payments if their incomes are below 150 percent of the federal poverty level, and they pay 10 percent of their incomes above that level. The federal government cancels remaining balances after 20 years for undergraduate borrowers and after 25 years for those with graduate debt. Borrowers who qualify for Public Service Loan Forgiveness see their debts wiped away after 10 years.

There are a lot of problems with the system. Aside from its complexity, borrowers must actively apply and then verify their incomes annually. Many who enroll fall out of the system because of the bureaucratic barriers. In some other countries, borrowers are automatically enrolled in a system of this sort and income data come through the tax system.

Under the recent Biden proposal, the IDR system would become significantly more generous. Already, many borrowers are not required to make any payments at all. The proposal would increase that number and cut payments in half for most other borrowers by raising the threshold for payments to 225 percent of the poverty level and reducing the share of income required for monthly payments to 5 percent. Estimates suggest that borrowers will repay an average of only 50 cents for each dollar borrowed.

It is easy to think of any policy that makes it easier for borrowers to manage their payments as a good one. But a loan program that distributes subsidies so broadly is not likely to be sustainable in the long run. Graduate students, who can borrow virtually unlimited amounts, already see a large share of the subsidies in the system, and that situation will be more extreme if monthly payments are lowered so much.

WHICH BORROWERS ARE MOST VULNERABLE?

Some groups of borrowers tend to borrow more than others pursuing similar types of education. Students at for-profit institutions borrow more than others and end up defaulting at very high rates. Leaving school without completing a credential is also a strong predictor of student loan default. Many students borrow relatively small amounts of money, but because they drop out, they do not get a significant financial benefit from their investments in education.

Black students borrow more than their white, Hispanic, and Asian peers. They come disproportionately from low-income, low-wealth families. Larger shares of Black students than of those from other demographic groups attend for-profit institutions. Black students are more likely to start college when they are older and to take longer to graduate. All these factors contribute to higher debt levels. Lower completion rates, labor market discrimination, and the absence of family resources all make repayment more difficult.

The Biden administration has actively forgiven debt for some groups of students, including those who are permanently disabled and those who attended institutions that defrauded them and/or closed. This type of debt forgiveness – as well as the extra $10,000 of debt Biden plans to cancel for borrowers who received Pell Grants as undergraduates because they came from low-income households – targets those most likely to face real financial problems.