Reforming Income Based Replacement Loans
Three types of policies income driven student loan programs, public service loan programs, and bankruptcy laws and procedures impact the ability of over-extended borrowers to obtain debt relief. This section looks at income driven loan programs and public service loan programs. We describe the program and discuss potential modifications.
Background on Income Driven Loan Programs:
Income driven loan programs tie monthly loan payments to annual income and offer loan forgiveness after several years. The Federal government offers at least four different income-driven loan plans — the revised pay as you earn repayment plan (REPAYE Plan), the Pay as you earn Repayment Plan (PAYE), the Income Based Repayment Plan (IBR plan) and the Income Contingent Repayment Plan (ICR Plan).
The terms and conditions of each of these plans differ and sometimes vary across date of enrollment. The largest income contingent plan is the IBR program. The IBR plan was favored by President Obama. President Trump has proposed consolidating all income driven loan programs into a modified IBR program. His alterations involve higher monthly payments and shortening the period before students receive loan forgiveness.
Description of IBR program: The primary objective of the IBR program is to help student borrowers avoid defaulting on their loans when their household income is low. This is accomplished by linking student debt to household income.
The second most important objective of the IBR program is potential loan forgiveness. Any outstanding balance on the IBR loan could be forgiven 20 or 25 years after enrollment, depending on the enrollment date. However, to obtain loan forgiveness the person must remain in the program for the entire period.
Under the IBR program, the required student loan payment is $0 when household income is less than 150% of the federal poverty line. When household income is more than 150% of the federal poverty line, the IBR payment is the minimum of 10% of disposable income or the standard payment on a 10 year-student loan. (Disposable income is defined as household income minus 150% of the federal poverty line.) Individuals with family income exceeding 10% of disposable income will make the standard payment for a 10-year loan.
Other important features of the IBR program include:
Government payments of monthly interest for up to three consecutive years if the IBR payment does not cover monthly interest under the 10-year repayment plan,
No capitalization of interest when income is less than 15% of disposable income,
Facilitation of eligibility for public loan forgiveness for student borrowers employed by public service organizations.
There are many limitations to the IBR program:
Under the program, it takes 25 years to get debt forgiven.
The Department of Treasury has ruled that any debt relief would be taxed at ordinary tax rates.
Under the IBR program borrowers must apply to their service annually for payment adjustments. The Consumer Finance Protection Board has reported that services often put obstacles in the path of borrowers applying to the IBR program.
These road blocks to annual enrollments will prevent many borrowers from ever getting any IBR debt relief.
The IBR program is of limited use to many households. The debt relief is based on household income, including income for both the student borrower and the income for the spouse. A decision to enter the IBR program made when a person is single may lead to higher payments after marriage. Married household must file separate returns to take full advantage of the IBR program. (Separate returns tend to result in higher tax payments than joint returns.)
Neither private student loans nor PlUS loans for parents can be included in an IBR loan.
One of the problems with IBR cited by lenders is that IBR will allow some borrowers to increase the amount they borrow without increasing their ultimate or expected payment obligation. The payment rules will cause some borrowers to increase the amount they borrow.
Potential Modifications to the IBR Program:
• Make it easier for student borrowers to enroll in the program. This would require clear rules and procedures requiring loan servicers to enroll applicants into the IBR program. Moreover, regulators would need to enforce these rules.
Currently the Trump Administration is moving in the opposite direction by rescinding rules covering the proper servicing of loans.
See this article for a discussion of Trump Administration IBR policies:
Betsy DeVos rescinds protections for student loan borrowers
• Allow student borrowers to include all PLUS loans and all private student loans in the IBR loan program. This provision is especially important because the use of PLUS loans and private loans have both risen in recent decades. The use of PLUS loans and co-signed private loans have both contributed to the increase in number of older Americans with student debt obligations. The percent of borrowers in the lower income quartile with a PLUS loan has gone from 2.96% in 1996 to 6.22% in 2022.
• Allow married couples participating in the IBR loan program to file joint tax returns.
• Donald Trump as a candidate for president called for two modifications of the IBR program – (1) an increase in annual repayments and (2) forgiveness after 15 years rather than 20 years. No actions towards implementing these proposals have been taken.
Next I address public service loan programs, which are facilitated by the IBR program.
Background on Public Service Loan Programs: Public service loan programs started in 2007 are designed to provide loan forgiveness to people who work at public service jobs and make 120 consecutive payments on their loan. The loan program is designed to help people with public service jobs in the IBR program obtain debt forgiveness after 10 years.
The Trump Administration has proposed ending the public service loan program. I am a bit mystified as to why the Trump Administration would target this relatively small program.
The program began in October 20007; hence, no one would have received loan forgiveness until 2017. As a result, as of this date 9/25/2017 there is no data on the number of people who have had their loans forgiven under the public service loan program or have had their assistance blocked by the Trump Administration.
I don’t believe many people are going to have their loans forgiven under this program. First, many people will switch from a public service job to some other position in the ten-year period. Second, late payments could make a person ineligible for loan forgiveness. Third, periods of loan forbearance could make a person ineligible for loan forgiveness. Fourth, (and possibly most importantly) people who do not enter and remain in the IBR program may lose eligibility for the loan forgiveness.
A Potential Modification:
I understand that society gains when people take public service jobs but I don’t like the fact that this program ties a person into a public service job for 10 years. In some cases, a person may be happier and more productive elsewhere. It might be useful to give people in public service jobs a lower interest rate for a short period of time rather than loan forgiveness after 120 consecutive on-time payments in a public service position.
I am very skeptical that public service loan program will help many people. Show Me the Numbers!
Concluding Remarks: I am also skeptical that the IBR program will prove effective in providing debt relief to a lot of people. The IBR program was the signature student debt relief program of the Obama Administration. My view is relatively few people will eventually obtain loan forgiveness under the IBR program. First, loan servicers are making it extremely diffficult for many people to enroll in the program. Second, many debts, including many forms of student loans are not covered by IBR. Third, many households which initially appear to benefit from the IBR program will end up paying more on their student debt in the long term when their financial status or marital status changes.
Economists are concerned about some of the incentives created by the IBR program The IBR program will also cause some borrowers to increase the amount they borrow because there is a possibility they could borrow more without repaying more. A more appropriate debt relief formula would plan for a positive relationship between amount borrowed and amount repaid under all circumstances.
My alternative debt relief program will improve status of both lenders and borrowers compared to IBR.
Proposal Four: Delayed Interest Rate Reductions on Student Loans
Proposal Four: Interest Rate Reductions on Student Loans After Several Years of Payments