The The term of termination of student loans has been attracting the attention of politics and university policy for a good year now. Despite the popularity of this extremely regressive idea, it is terrible. Fortunately, there is a better, more moderate way of tackling student national debt. And it’s hiding in sight.
Income-driven repayment (IDR), an existing suite of programs that work somewhat poorly, can be enhanced to ensure that not a single borrower ever makes an unaffordable federal student loan payment. With IDR, monthly payments are tied to the borrower’s income and unaffordable balances are ultimately given away. IDR does this in a way that minimizes moral risk and offers benefits in a really progressive way – with more benefits for those who invested in a college degree and took on debt for it, but didn’t get the promised return on high paying jobs. IDR also makes study more accessible to children from low-income families, allowing higher education to act as a mechanism for social mobility.
The monthly installments of traditional loans are set at the beginning, with repayment and interest spread over a certain period of time. In contrast, IDR allows borrowers to make monthly payments that are a fixed percentage of their current disposable income. If you have a high income, you pay the full amount; if you have a low income, you can make a reduced payment without penalty. This ensures that the monthly payments are affordable. The balance is waived once a borrower has made a required number of IDR payments. This takes anywhere from ten to 25 years, depending on the student’s eligibility and choice of IDR program. Borrowers may not like the balance hanging over their heads for so long, but the reduced monthly payments (often reduced to zero) mean the process isn’t overly onerous.
By reserving services for those really in need, the IDR mechanism also reduces the perversion of incentives often associated with the introduction of safety nets. A less targeted assistance program, like the proposed student loan waiver, would likely encourage prospective students to borrow more, attend more expensive schools, and put less effort into limiting the cost of living (even paid for with loans). . It would also feed hope for another politically-backed round of lending in the future. It adds even more costs to the taxpayers who ultimately pay the price for these programs. For their part, colleges and universities would raise prices to respond to the surge in demand, exacerbating the already out of control inflation in the higher education sector.
Some may wonder if a student borrower safety net is really necessary. But if we want more Americans to use our higher education system, which includes both professional education and degree programs, we need to minimize the financial risk to students. While investing in higher education generally pays off, degrees don’t always generate high revenues that would justify the cost. Students who start but don’t finish school are worst off as they end up having to repay a significant loan balance with no access to a level of income that would make repayment affordable. Without a safety net, college is still not really affordable for students from low-income families. Providing relief through a safety net allows for a more efficient allocation of resources because those who invest in college and embark on lucrative careers do not have to pay benefits.
Despite the suitability of the IDR system for the political challenge at hand, the system has not worked well. This is mainly because IDR is administered through a variety of programs, each with different eligibility criteria and a range of program parameters. The amount borrowers are likely to have to pay is calculated differently depending on the program, as is the number of years before borrowers are entitled to their balance. The result is a system that is too complex to navigate and many borrowers are unaware of the benefits available to them. While IDR is now universal to all federal student borrowers, it wasn’t until after a series of legislative and executive interventions between 1992 and 2015 that a patchwork of loosely related programs was put together. Actual evidence on how IDR has been used is limited, but anecdotes about the challenges of navigating the system, even by finance-savvy consumers, point to systemic problems. This shaky policy framework urgently needs to be replaced with a single, easy-to-use, income-driven repayment plan that can be universally marketed and better understood.
Sensible people may disagree on how generous IDR should be. Shifting the conversation away from mass lending to reforming the IDR would be a step in a more equitable and efficient direction.