New Report Questions Equity and Efficiency of Student Loan Income-Based Repayment Policies
October 19, 2012
Under IBR, borrowers' federal student loan payments are capped at 10 percent of their incomes and any remaining debt is forgiven after 20 years of payments. Under the new IBR, a borrower's annual loan payment is equal to 10 percent of his or her adjusted gross income (AGI), after first deducting an allowance for living costs. In 2011, the Obama administration announced that it would make this plan available to borrowers who took out their first loans in 2008 or later and took out at least one loan in 2012 or later-and that eligible borrowers may be able to enroll by 2012 if regulations are finalized by then. The U.S. Department of Education plans to finalize changes to the IBR regulations by the end 2012.
In the report Safety Net or Windfall? Examining Changes to Income-Based Repayment for Federal Student Loans, The New America Foundation used their IBR calculator to demonstrate that those making low incomes (AGI of less than $38,000) will only save $5 to $20 each month when the cap is lowered from 15 to 10 percent. Middle-income borrowers ($38,000 to $62,000) will see varied outcomes depending on the level of debt. Those with student loan totals less than $25,000 will generally benefit from lower payments early in their careers, but as their income grows, the additional interest that accumulates during these early years will yield a larger total amount paid than simply consolidating immediately after college. Students who borrow more than $25,000 will experience significant levels of loan forgiveness under the new 20 year forgiveness policy. The Foundation finds that there is virtually no cost in the form of interest for any additional dollar taken out above $25,000, and no repayment costs (principal or interest) for anything greater than $60,000.
High-income earners (AGI above $62,000) stand to receive the greatest financial benefits. Those with low loan levels will end up paying off their entire principal and interest for approximately the same amount as their fixed payments (if they even qualify for IBR). High-income earners who accumulated significant debt in graduate school (while undergraduates can only borrow $31,000, graduate students' limit is just the cost of attendance) will have larger nominal benefits from the 10 percent cap than lower income borrowers (potentially hundreds of dollars less each month than the original IBR program), but will not face exacerbated interest rates later on due to the 20 year forgiveness clause.
The New America Foundation concludes that the new IBR plan is an inefficient use of federal funds, since it gives most of its benefits to borrowers with higher incomes. The new IBR rules also give borrowers to borrow amounts greater than $25,000, and essentially give no incentive to stop borrowing after a student accumulates $60,000 in debt. The risk-free borrowing that occurs over $60,000 also eliminates graduate programs' incentive to curtail costs. In fact, an opportunistic graduate program may exploit these incentives and use federal loans to raise significant capital.
The New America Foundation proposes that rather than forgiving massive graduate school debts, specifically those of high-income earners, the federal government should focus on making undergraduate education more accessible. Significant overhauls to the new IBR program should limit what the Foundation deems as a financial "windfall" for high-income borrowers. Thus, the Foundation believes, the new IBR policies should remain in place for low-income borrowers, but revert back to harsher repayment options for those making higher incomes. Specifically, the report suggests lengthening the term to 25 years and increasing the payment cap to 15 percent or even eliminating the cap if a borrower's income reaches a certain level. Furthermore, they suggest increased clarity and transparency in these policies.
The full report is available for no charge on the New America Foundation's web site.
James D. Ward
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