A hidden gem in the student loan plan: improved income-driven repayment

Last month, President Joe Biden announced a suite of policies aimed at providing relief for many federal student loan borrowers. Somewhat lost in the public debate — which tended to focus on the administration’s announcement of up to $20,000 in federal student loan cancellation for borrowers with individual incomes under $125,000 — was the proposal for a new income-driven repayment plan, which could provide significant long-term assistance to many borrowers, especially those with low incomes and who may be at risk of delinquency and default.

About 30 percent of federal student loan borrowers are enrolled in the current iteration of income-driven repayment (IDR) plans, which allow borrowers to make monthly payments based on their income and family size — with some payments as low as $0. After 20 years (for undergraduate loans) or 25 years (for graduate loans) of qualifying payments in these plans, borrowers can have any outstanding balance forgiven. The plans have a lower delinquency and default rate than the standard 10-year plan in which borrowers are automatically enrolled when they first enter repayment. In the standard plan, monthly payments are based on the total amount of the loan.

Helping borrowers avoid default is no small matter: Defaulting on student loans can lead to serious financial consequences such as wage garnishment, money withheld from tax refunds and damage to credit scores. And before the pause on the repayment that began in March 2020, some 20 percent of all borrowers were in default on their student loans.

Yet despite the advantages of IDR plans, research has found that problems with the plans’ design dissuade some low- and middle-income borrowers from enrolling.

The Pew Charitable Trusts has identified three key areas for reform of IDR plans: increased affordability, specifically for low-income borrowers, decreased balance growth and simplified processes and plans to ease enrollment and annual re-enrollment.

The proposal the White House announced last month would go a long way to addressing these areas.

Sixty-one percent of borrowers responded to a Pew survey by saying that affordability was the reason they chose IDR; nearly half of respondents said they still found their IDR payments unaffordable. The White House plan tackles affordability in several ways. It lowers the amount of discretionary income used to calculate an undergraduate borrower’s payments from 10 percent to 5 percent. It increases the amount of a borrower’s income exempted from the payment calculation by redefining discretionary income as the difference between a borrower’s adjusted gross income and 225 percent of the federal poverty guidelines (as opposed to 150 percent in current IDR plans), adjusted for the borrower’s family size and state of residence. And it creates a still-to-be-announced weighted rate to calculate the payments of borrowers who have both undergraduate and graduate loans. These changes are likely to not only substantially lower payments for many borrowers, but also increase the number of borrowers eligible for a $0 monthly payment.

Current IDR plans lower monthly payments for many borrowers, but the flip side of lower monthly payments is that the amount of unpaid interest that accrues on borrowers’ accounts each month will increase, often leading to growing balances. Borrowers in Pew focus groups reported that this balance growth discouraged them from enrolling and remaining in an IDR plan — especially as the prospect of forgiveness after 20 years of qualifying payments felt out of reach. The White House proposal will target this issue by providing a subsidy to fully cover borrowers’ monthly unpaid interest if they make their monthly payments. In addition, borrowers with balances of $12,000 or less would have their balance forgiven after 10 years of qualifying payments instead of 20.

Finally, to simplify enrollment in IDR plans, the White House also announced that by next summer the Department of Education will implement provisions of the Fostering Undergraduate Talent by Unlocking Resources for Education (FUTURE) Act of 2019. This move will streamline data sharing of income and family size between the department and the Internal Revenue Service for borrowers who opt-in. Currently, IDR borrowers must manually recertify this information each year to remain in their repayment plan. The Department of Education and the Consumer Financial Protection Bureau have found that many borrowers experience issues with this recertification process, contributing to some borrowers being unable to re-enroll in their IDR plans before the annual deadline.

For the past year, the Department of Education has worked with stakeholders to create a new IDR plan; the White House proposal demonstrates that the department carefully considered the research and the needs of borrowers. As the rollout proceeds, the department should continue to find ways to simplify IDR specifically and the student loan repayment system as a whole, especially as the payment pause approaches its scheduled end on Dec. 31, 2022. 

After more than two and a half years, borrowers expect and should benefit from an improved federal student loan repayment system.

Regan Fitzgerald is a manager and Brian Denten is an officer with The Pew Charitable Trusts’ project on student borrower success.