Proposal Four: Interest Rate Reductions on Student Loans After Several Years of Payments
The previous post concluded that IBR loan programs will likely prove ineffective at providing debt relief. First, many people who are initially good candidates for the IBR program end up paying more on their loans when their financial status and marital status change. Second, burdensome annual qualification process means very few people will eventually receive loan forgiveness.
Proposal four is a potential improvement over IBR.
Proposal Four: Reduce or eliminate interest on student loans after 12 years of scheduled payments. The loan agreement would also allow for more years of partial negative amortization of interest when the borrower’s income was low. However, the loan agreement would not allow for forgiveness of principal.
Comments on this Proposal:
The elimination of interest rates after 12 years reduces lifetime interest costs for all people where the loan maturity is greater than 12 years. However, people with a loan maturity of less than 12 years (10 years is standard) will pay less in interest than people with longer maturities.
Delinquent borrowers would be reported to credit bureaus, penalties could be applied to overdue accounts, and overdue accounts would be handled by collection agencies, even after the interest rate was reduced or eliminated.
The lower interest rate on this loan after 12 years could be coupled with a shortening of the loan’s amortization schedule. The more affordable payment could result in the government being repaid quicker than otherwise. In one example, the elimination of interest after 20 years reduces the annual interest rate from 4 percent to 3.53 percent while reducing loan maturity from 20 years to 18.8 years.
Cash flows to the lender under the interest rate reduction proposal are more predictable than cash flows under the IBR program. As a result, it may be easier to securitize student loans with an interest rate reduction provision than IBR loans.
Concluding Remark: I believe that lenders and many borrowers will be better off under a proposal which eliminates interest rates after12 years than under IBR. This proposal targets people with demonstrated need without creating an incentive for people to over borrow. However, this proposal will not provide enough debt relief for borrowers in extreme difficult. These borrowers could benefit from modifications to the bankruptcy code, which currently favors creditors over both debtors and lenders.
Proposal Five: Potential Changes in Bankruptcy Law