Biden’s Silent Cancellation of Student Loans: Means-Based Repayment Extension

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The Biden administration unveiled its proposed expansion of income-driven repayment (IDR) for student loans on Tuesday. The proposal will reduce monthly payments for most borrowers and dramatically increase the cost of the loan program. In addition, it threatens to further solidify the role of debt in our higher education system, with potentially dramatic consequences for tuition levels and future borrowing rates.

The Department of Education (ED) invites citizens to respond to the draft regulation. Comments must be submitted within 30 days. After that, ED will issue a final rule and the plan will likely go into effect sometime this summer.

What the plan does

Rather than create an entirely new repayment plan, the administration plans to revise an existing IDR plan, known as REPAYE, to make it more generous. These are the main changes:

  • Income exempt from student loan payments will rise from 150% of the federal poverty line to 225%. For a single borrower in 2023, this threshold is $30,578.
  • For undergraduate student loans, payments are set at 5% of income above the threshold, instead of 10%. Payments on graduate loans remain 10% of income above the threshold.
  • If a borrower’s monthly payment does not fully cover the accrued interest on her loans, the remaining interest is waived.
  • Those who have borrowed $12,000 or less will see their outstanding balance canceled after making 10 years of payments. The time to cancel is extended by one year for every $1,000 borrowed.
  • Borrowers who are only undergraduates enjoy full loan forgiveness after 20 years of payments; graduate loan borrowers get cancellation after 25 years. These are unchanged from the current version of REPAYE.

The proposal also makes several changes to the wider infrastructure around IDR, including:

  • ED allows borrowers to count time spent on deferral or forbearance towards loan cancellations. Depending on the type of deferment or deferral, borrowers may need to make catch-up payments in order to claim this benefit.
  • Borrowers who are more than 75 days past due on their loans are automatically enrolled in an IDR plan, provided ED has access to their income information from the IRS.
  • To streamline the confusing array of refund options, ED will be phasing out new enrollments in most IDR plans except the revised REPAYE plan.
  • ED will publish a list of programs that provide “low financial value” to deter students from enrolling.

The proposal contains a handful of good provisions and quite a few bad ones. In addition, some reforms are notable for their absence from the draft regulation.

The good: auto-enrollment and new perks for low-balance borrowers

By reducing monthly payments, existing IDR plans reduce the risk of default. But a lack of awareness, plus paperwork, prevents many struggling borrowers who could benefit from IDR from accessing it. Automatically enrolling delinquent borrowers in IDR will help address this problem, as will streamlining the number of repayment plans.

Accelerated forgiveness for low-balance borrowers is also a good idea. Distressed borrowers usually only attended college for a few semesters before dropping out, meaning most people struggling with their loan payments borrowed very little. The new IDR plan will forgive students who have borrowed less than $12,000 after just 10 years, instead of the usual 20 or 25 years.

While this change will cost money ($3.7 billion, according to ED cost estimates), it is cheaper than most of the other provisions of the proposed new plan. The expenses may be worth it: Students who have borrowed small amounts and have not earned a degree may be reluctant to enroll in an IDR plan if forgiveness is 20 or 25 years away. Forgiveness after 10 years, on the other hand, could encourage these borrowers to pay back their loans and not default.

By making these changes yourself, the student loan amortization system could have been improved at a minimal cost. But the other provisions of the new IDR plan will drive up the cost of the student loan program and lay the foundation for debt-funded tuition increases.

The Bad: Exploding costs and higher tuition

The central provisions of the new IDR plan — a higher income exemption, a lower appraisal rate for undergraduate borrowers, and interest waiver — will lower monthly payments for most borrowers and significantly reduce the amount students pay overall for their loans.

This may sound like a good thing at first. But it will fundamentally reshape incentives in our higher education system, with many unintended consequences.

Students enrolling in diploma or certificate programs with modest financial returns pay back only pennies for every dollar they borrow from taxpayers. According to calculations by Adam Looney of the Brookings Institution, even students in typical-return programs only pay back 50% of what they borrow.

For certain programs at community colleges, especially cosmetology, students can have their loans forgiven without ever making a single payment. President Biden can achieve his dream of a free community college, but only by exploding the student loan system in the process.

Since most undergraduate students will receive a grant on their federal loans, the rational thing to do is to borrow the maximum possible amount from the taxpayer and then pay back through the new IDR plan. Currently, 45% of all students and 77% of community college students do not take out loans. Under the new plan, those students leave money on the table.

The result is a greater willingness to borrow. The Biden administration plans to reduce the burden of student loans, but it could actually reinforce the role of debt in our higher education system. Borrowing for college will become more common, especially at community colleges and previously low-cost public schools. Institutions will try to capture this new federal generosity through tuition fees.

The Absent: Fair cost estimates and accountability

ED’s proposed rule sets the cost of the new IDR plan at $138 billion. That is almost certainly an underestimate, for several reasons.

First, it assumes that the Supreme Court will uphold President Biden’s plan to cancel $430 billion in student loans. With so much debt already forgiven, the new IDR plan adds less cost to the margin. But if the court scraps the loan cancellation scheme, as is likely, borrowers who would have received forgiveness will instead repay their loans through IDR. The cost of making IDR more generous will skyrocket.

Second, the cost estimate does not account for the likelihood that some borrowers in non-IDR plans will move to IDR. This makes no sense, as a central goal of the proposal is to provide more borrowers with an affordable monthly payment through IDR. Third, the estimate does not account for increases in loan or tuition rates resulting from the enactment of the IDR plan. Factoring in these effects, independent analysts believe the true cost of the plan could exceed $500 billion.

The Biden administration is making only a feeble attempt to counter the impact of the new plan on tuition and borrowing. ED plans to publish a “disgrace list” of programs that offer “low financial value” to deter students from enrolling. While more transparency is always welcome, research has shown that such shame lists do little to control tuition or discourage enrollment.

To make the new IDR plan fiscally sustainable, transparency is not enough. The federal government should stop funding higher education programs that leave students with too low an income to pay back their loans. A proposal is in the works to do this for private colleges, but programs at public and private non-profit schools are exempt. Without meaningful accountability, the new IDR plan will provide little more than a blank check for colleges to continue charging tuition and earning low degrees on the taxpayer’s dime.

Means-tested repayment requires responsible reforms

The means-tested repayment system has its share of problems. But solving those problems doesn’t require a massive new injection of taxpayers’ money. Instead of cutting payments for everyone, ED should focus on low-cost interventions to improve IDR, especially simplification and automatic enrollment of delinquent borrowers.

As written, the proposed rule will fundamentally change the student loan system. New loan subsidies will make it rational for students to borrow more, a fact that colleges will certainly take advantage of. While President Biden’s education department set itself the goal of reducing the burden of student loans, it could ultimately lead to strengthening debt as the central pillar of higher education funding.