1. How policymakers can lower monthly payments
As IDR plans have been added and amended, monthly payments have decreased substantially. But even if payments are manageable for most, they should not make borrowers worse off than if they had not gone to college.
Policymakers have two tools to lower monthly payments: exemption levels and assessment rates. Exemption levels set the income threshold under which no payments are due, and assessment rates define the share of a borrower’s nonexempt income required for payment. The current exemption level is 150 percent of the federal poverty level for the borrower’s family size, above which income is usually assessed at 10 percent. Here, we compare two policy options for increasing the exemption level and two options for changing the assessment rate.
Let’s consider our two borrowers with $30,000 of debt, Michael and Janet:
Debt: $30,000
Starting income: $30,000
Debt: $30,000
Starting income: $50,000
If the exemption threshold rose to 200 percent of the federal poverty level (FPL), income below the earnings of the typical high school graduate would be exempt. In this scenario, Michael and Janet would each see their initial monthly payments decline by $54, but Michael’s balance would increase to more than $35,000 while he is in repayment, and his debt forgiven after 20 years would nearly triple.
In contrast, if the assessment rate decreased to 5 percent, Michael and Janet would see their monthly payments cut in half, but the dollars saved would be greater for Janet, who had a higher payment to start. If policymakers enacted a hybrid assessment rate, where only the first $10,000 of debt was assessed at 5 percent and the rest at 10 percent, Michael and Janet would each see a $42 monthly decrease in their initial payments, while Michael’s highest debt balance would increase by around $3,000. Michael would also see the amount of debt forgiven after 20 years rise to slightly more than $16,000. (We measure amount forgiven and total repayment using present value to more accurately account for the lower value of money in the future.)
A higher exemption threshold reduces payments equally for borrowers with the same amount of debt, but a lower assessment rate disproportionately benefits borrowers with higher earnings.
2. How policymakers can create more equitable loan forgiveness timelines
Many students try to limit their loan debt by making concessions, such as working more hours, living at home, or attending a less expensive school. But the current IDR system doesn’t take these sacrifices into account. Instead, borrowers with similar incomes frequently make the same total payments before having their remaining balance forgiven, regardless of how much they borrowed.
Policymakers can adjust forgiveness timelines to make a student’s total payments partly a function of how much they borrowed. This policy change shortens the time in repayment for those with small debts and maintains affordable monthly payments. Here, we compare the current forgiveness timeline with a shortened timeline for all borrowers and with a timeline tied to the amount borrowed.
Let’s focus on Chidi and Michael, who have the same income but different debt amounts:
Debt: $30,000
Starting income: $30,000
Debt: $100,000
Starting income: $30,000
Chidi and Michael both finished their bachelor’s degrees with $30,000 of debt, but Chidi went to graduate school and borrowed an additional $70,000. Under current policy, because Chidi and Michael have the same incomes, they make the same payments every month for 20 years, with Chidi having more than 13 times the amount of debt forgiven as Michael. Put simply, the extra loans Chidi took out have no impact on the payments he makes, and he and borrowers like him receive the largest benefit through loan forgiveness.
If policymakers shorten forgiveness timelines to have all unpaid balances forgiven after 15 years, as some advocates have proposed, Chidi and Michael would pay less overall and have more forgiven, but Chidi would still receive the largest subsidy.
But if policymakers tie the timeline of forgiveness to the amount borrowed, Michael would make payments totaling $22,307 over 15 years, before having about $17,000 forgiven. Chidi, on the other hand, would be required to pay longer because he borrowed more. Over 30 years, Chidi would make total payments with a present value of nearly $62,000 before having around $80,000 forgiven. With this policy change, students like Michael who borrow less are not unfairly punished by having to repay as much as those who took on larger debts.
3. How policymakers can mitigate growing debt balances
How much interest borrowers pay varies by IDR plan. If monthly payments are too small to cover interest charges, the government will cover a portion of the interest each month for some borrowers. Other borrowers have all the unpaid interest added to their debts. As unpaid interest adds up, borrowers’ loan balances—and sometimes their monthly interest charges—increase.
By either changing the interest rate charged on student loans or changing how IDR plans treat interest charges, policymakers can prevent borrowers from having their balances balloon. Here, we compare a 4.5 percent interest rate where unpaid interest is added to the loan balance with two interest rate approaches: eliminating all interest charges altogether or eliminating interest on only the first $10,000 of debt. We also compare two strategies for limiting the accumulation of unpaid interest: government coverage of any interest above the required monthly payment and government coverage of up to $50 of unpaid interest each month.
For these policies, let’s consider how our graduate school borrowers, Chidi and Tahani, fare:
Debt: $100,000
Starting income: $80,000
Debt: $100,000
Starting income: $30,000
Under current policy, Chidi’s $100,000 of debt will rise to more than $147,000 before it is forgiven after 20 years. But Tahani can cover the interest payments each month because of her higher income, so her debt never exceeds her original amount borrowed, and she repays it all with interest.
The interest doesn’t affect Chidi’s monthly or total payments in any of these four policy scenarios. No matter how we treat interest, Chidi will always repay the same amount as he does under current policy. But charging 0 percent interest or forgiving interest above the required monthly payment prevents Chidi’s debt balance from exceeding his original amount borrowed.
For Tahani, the story is similar. Because her income is high enough to cover interest, her maximum balance stays the same across all four scenarios and her amount repaid stays the same in both interest forgiveness scenarios. But Tahani would save almost $40,000 on her total repayment if interest rates were 0 percent, and she would spend five fewer years in repayment.
Changing the treatment of interest reduces the increases in balances; scenarios that eliminate or forgive all interest offer a large subsidy to high-debt borrowers. But these changes do not affect monthly payments for borrowers and limiting the accumulation of unpaid interest does not affect the total amount repaid, except for borrowers whose incomes rise rapidly while they are in repayment.
Although the policy changes we’ve discussed can have large effects on the monthly payments, forgiveness timelines, and maximum balances of borrowers with a lot of debt, many of these changes would not have much effect on borrowers with smaller debt balances, especially if they have low incomes. So let’s briefly highlight our borrowers with $10,000 in debt, Jason and Eleanor:
Debt: $10,000
Starting income: $20,000
Debt: $10,000
Starting income: $40,000
With only $10,000 of debt apiece, Jason and Eleanor have small debts compared with many Americans who have student loans. Changing the treatment of interest does not affect Eleanor, who makes twice what Jason does and pays off her full debt in five years with $172 starting monthly payments. Jason would see a small benefit, as his balance would not increase, but he would still make the same payments over 20 years, regardless of how much unpaid interest the government covers.
Similarly, changing assessment rates or exemption levels has little effect on Jason, whose monthly payment is already low ($6). But Eleanor’s initial monthly payment of $172 would fall by $53 with an exemption level of 200 percent of the federal poverty level and by $86 at a 5 percent assessment rate, leading her to spend more time in repayment and pay a larger total amount before paying off her debt. The roles would reverse if policymakers tied forgiveness timelines to the amount borrowed, with Eleanor still paying off her debt in five years because of her higher income but Jason, who earns less, speeding up his forgiveness timeline from 20 years to only 7 years and paying less altogether.
Although neither borrower would benefit the most from any of these policy changes, special attention should be paid to their situations, as borrowers with low debt amounts—many of whom did not complete their college programs—tend to struggle the most and default most often. There is no silver-bullet solution for these borrowers, but a combination of raising exemption levels, lowering assessment rates, and tying forgiveness timelines to amount borrowed can help.