Reforming IDR Plans: An Opportunity to Improve Borrower Outcomes and Enhance Equity
Nearly one out of five federal student loan borrowers were in default before the Department of Education suspended interest and loan payments in response to the COVID-19 pandemic. This high prevalence of default, along with overall declines in repayment rates, demonstrate that borrowers are struggling to pay back their student loans. With monthly payments set to resume at the beginning of next year, a repayment crisis may be on the horizon.
Although calls for mass forgiveness have dominated headlines, most student loans are already eligible for eventual forgiveness via income-driven repayment (IDR) plans. IDR plans limit a borrower’s monthly loan payment to a portion of their discretionary income, with the goal of ensuring these payments are affordable. For those with low or no income, payments can be as low as $0. Additionally, IDR plans forgive a borrower’s unpaid outstanding loan balance after 20 or 25 years in repayment, providing borrowers with eventual relief if their income is too low to repay their student debt in full.
The number of federal student loan borrowers enrolled in IDR plans has almost tripled since 2013. These plans have proven effective at helping borrowers avoid default, an outcome that harms their ability to borrow to attend school, buy a house or car, or even utilize a credit card in the future. Borrowers who enroll in an income-driven plan within a year of entering repayment are about half as likely to default as borrowers in fixed-payment plans.
Despite the benefits of IDR plans for struggling borrowers, however, the individuals most in need are often unaware of these plans or face confusion and red tape when trying to enroll. Additionally, although these plans offer necessary relief for many, their current structure disproportionately subsidizes borrowers with the highest outstanding loan balances, particularly those who pursued graduate degrees. These characteristics are strongly correlated with the borrowers who have the highest career earnings.
Reforms to IDR could therefore better support struggling borrowers and prevent those with the highest incomes from receiving a windfall. Specifically, BPC recommends three reforms:
- Automatically enroll borrowers in a simplified IDR plan
- Eliminate the standard repayment cap
- Use a progressive payment formula for the new simplified IDR plan
Automatic Enrollment in a Simplified IDR Plan
Currently, borrowers hoping to enroll in an IDR plan must choose from four different plans, all with different monthly payment formulas and eligibility requirements. To remain enrolled, borrowers must also reapply annually by submitting their tax information. This confusing and onerous process prevents many borrowers—especially borrowers of color—from accessing the relief intended under IDR: non-white students are 7% more likely to remain in costly loan forbearance—where students temporarily forgo making loan payments but interest continues to accrue and capitalize, leading to higher total lifelong payments—instead of switching to an IDR plan.
To eliminate IDR enrollment barriers and promote more equitable access to relief, all federal student loan borrowers entering repayment should be automatically enrolled into a single, streamlined IDR plan. Under this system, the Department of Education would notify borrowers entering repayment that they are being placed on an IDR plan (which would be the only one available to new borrowers). Borrowers could then switch to a standard, graduated, or extended plan if they prefer. Both the initial enrollment and the annual process of recertifying income could be streamlined and automated by data sharing between the IRS and Department of Education.
By solving current inequities in access and seeking to make every borrower’s monthly payments affordable, automatic enrollment in IDR would likely reduce delinquency and default rates, reversing current trends. It would also benefit low- and middle-income households more than high-income households.
Eliminate the Standard Repayment Cap
The standard repayment cap is a component of several IDR plans that limits a borrower’s monthly payment to the monthly amount owed under a standard 10-year repayment plan. This cap disproportionately benefits high-income borrowers by allowing them to avoid paying the full portion of their discretionary income—generally 10% in most IDR plans—if their monthly payment is calculated to be higher than it would be under a standard 10-year plan. With this cap, therefore, high-income borrowers are able to pay back less of their outstanding balance before having the remainder discharged through Public Service Loan Forgiveness (which forgives a borrower’s outstanding federal student debt if they work for a public or qualifying non-profit employer and make payments for 10 years) or forgiven at the end of their repayment period under IDR.
Eliminating the standard repayment cap would better align borrowers’ monthly payments with their ability to repay, reducing the disproportionate subsidies received by high-income borrowers and saving taxpayer funds. The Congressional Budget Office estimated that eliminating the cap would yield $10 billion in savings over 10 years.
Create a Progressive Payment Formula
In addition to automatically enrolling borrowers in a streamlined IDR plan, creating a progressive payment formula for that plan would further improve affordability for struggling borrowers and reduce regressivity stemming from the forgiveness aspect of the student loan repayment system. In current IDR plans, monthly loan payments are determined by a flat percentage of a borrower’s discretionary income—income above a cutoff tied to borrowers’ basic needs. Under a progressive payment formula, a borrower would see their monthly payments increase more quickly as their income rises. For example, lower-income borrowers could have their monthly payments set at only 5% of discretionary income—a lower percentage than under current IDR plans. For those with higher levels of discretionary income, the marginal rate could be 10%, while those with the highest levels could face a marginal rate of 15%.
A progressive repayment formula would provide low-income borrowers—who often struggle the most to repay their loans—with more affordable payments, while ensuring that high-income borrowers repay their loans promptly, making it more difficult to draw out repayment and benefit from eventual forgiveness.
Our three suggested reforms—automatically enrolling borrowers in one streamlined plan, eliminating the standard repayment cap, and creating a progressive repayment formula—would improve access to IDR and create a more equitable and sustainable student loan system. They could also address rising default rates. Although automatic enrollment in IDR would create costs for the government through eventual forgiveness, it would also reduce the costs associated with collecting on defaulted loans, the full value of which the government does not recover. Moreover, the other reforms could produce additional savings to help cover the costs associated with automatic IDR enrollment. Although not all of these reforms can be accomplished solely through regulations, the current Department of Education Negotiated Rulemaking effort could provide an opportunity to address the loan repayment issue.
As borrowers continue to struggle repaying their student loans, policymakers have a powerful opportunity to improve borrower outcomes, enhance equity, and establish a more sustainable student loan repayment system.
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