Introduction:
The Biden Administration, to its credit, has tried to reduce burdens caused by record levels of student debt. However, the Administration’s preferred solutions have been blocked and some of the on-going and newly implemented programs appear ineffective.
- The Supreme Court blocked a one-time discharge due to COVID.
- The payment shock from the termination of the COVID-era student loan payment freeze will reduce consumer spending and could facilitate a recession.
- The Biden Administration proposal for expanded Income-Driven loans is complex and less effective than interest rate reductions.
- Low levels of on-time graduation remain an important factor in high student debt burdens.
- Many student borrowers leaving school prior to the completion of a degree have a difficult time repaying their student loans.
The objective of this post is to provide and explain potential economically efficient solutions to these problems.
Student Debt Proposals:
Proposal One: Issue an executive order setting the interest rate on all student loans at 0 percent for the first two years of the loan. The proposed reset of interest rates will be both less costly to taxpayers and more effective to student borrowers than the SAVE IDR loan program currently implemented by the Administration.
Analysis:
- The executive order would be challenged in the courts but a potential court challenge did not prevent the Biden Administration from implementing the SAVE IDR program through executive order.
- Delinquencies would fall at the beginning of careers when workers tend to have lower salaries.
- A lower interest rate and quicker repayment of loans would allow young workers to increase household savings, a necessary prerequisite for many Social Security reform proposals under consideration.
- Quicker repayment of student loans by young adults should eventually reduce the number of older adults with unpaid student loan balances in retirement
- An initial interest rate of 0 percent would reduce demand for Income Driven Replacement (IDR) Loan programs, which will benefit both student borrowers and the Treasury.
- The proposed elimination of interest rates at the start of the repayment period reduces the number of households who will be unable to obtain any debt relief due to changes in marital status and family income.
Proposal Two: Modify the standard 10-year and 20-year federal student loan contract to eliminate all interest charges at the maturity of the loan. Treat unpaid student loan balances after the maturity of the student loan as a tax obligation spread over 3 to 5 years.
Advantages of proposed changes:
- The interest rate of zero at the maturity of the loan provides some relief for people who have had difficulty repaying their loan, regardless of whether they initially selected an IDR or conventional loan.
- This change will reduce the number of people who have their Social Security checks garnished because of outstanding student loan obligations.
- The proposal creates an incentive for borrowers to select a standard student loan contract instead of an income driven loan contract, which reduce uncertainty associated with IDR loans and could reduce costs to taxpayers.
- Under the modified student loan contract, the borrower with a larger loan will always repay more than the borrower with the smaller loan over the lifetime of the loan. By contrast, under the IDR program it is possible an increase in initial student loan debt does not increase the amount repaid over the life of the loan.
Proposal Three: Modify IDR loan programs to provide for gradual partial discharges of student debt instead of a complete discharge of the remaining balance at the maturity of the loan.
- Discharge formula might involve 10 percent of previous 24 payments after receipt of 24 payments.
- Limit discharge at the maturity of the loan to 50 percent of the outstanding balance.
- Undischarged loan balance will be restructured into a new short-term low interest rate loan and perhaps be treated as a tax liability.
Advantages of proposed changes to IDR contracts:
- The quicker partial discharge gives borrowers an incentive to make payments on time to maximize debt relief.
- The quicker partial discharge reveals potential problems with the recording of loan payments earlier. Currently, payment problems are not revealed until maturity when the borrower apples for the complete loan discharge, leading to a delay or even in a denial of the loan discharge.
- The limitation of the final discharge to 50 percent of the outstanding loan balance will cause borrowers with larger loans to have a higher debt at maturity than borrowers with lower debt, reducing the tendency for borrowers to increase the amount they borrow in anticipation of a complete discharge.
Go here for a discussion of the Biden Administration’s IDR reform effort.
Proposal Four: Provide greater financial assistance to all first-year students with the goal of eliminating all student debt incurred during the first year of post-secondary school education.
Analysis: Increasingly, some education after high school is necessary for career advancement. Many student borrowers who leave school prior to the completion of the degree have great difficulty in repaying their loans. Increased financial assistance for first-year students will increase access to higher education for underserved groups and will assist people likely to have the most difficult repaying loans.
Proposed changes to first-year financial assistance programs:
- Provide federal or private tax-preferred grants to institutions that agree to eliminate student debt incurred by first-year students.
- All state and private institutions that agree to match the new federal/private funds are eligible for the new grants.
- Participating institutions are not allowed to provide federal student loans to first-year students.
- Benefit is available at both two-year and four-year institutions.
- Additional benefits could be provided to students transferring from a two-year to four-year institution.
Advantages:
- Program reduces payment problems and default rates by student borrowers that leave college early prior to the completion of their degree. (Students leaving college without a degree after only one or two years of study tend to have an especially hard time repaying their student loan.)
- Program will reduce typical college debt levels.
- Absence of debt could allow a person to reenter school later in life when she is more prepared for higher education.
- Proposed goal of a debt-free first year of post-secondary education is far less expensive than previous free college or debt-free colleges proposals.
- Program allows more highly qualified people to consider a four-year college and would reduce the number of students who believe a two-year school is the only option.
- Prospect of additional assistance for transfer students could further reduce costs for students who start their post-secondary career at a two-year college and mitigate impact of credits lost through the transfer process.
Proposal Five: Modify the bankruptcy code to allow for the discharge of private student debt in bankruptcy and to provide priority to federal student debt payments over all consumer loans in chapter 13 bankruptcy plans.
Analysis: Student debt has always been difficult to discharge in bankruptcy. The 2005 Bankruptcy reform law discouraged Chapter 7 bankruptcy in favor of Chapter 13 and made it more difficult to discharge private student loans in bankruptcy. Moreover, in most instances current law results in higher priority for consumer debt over all student loan debt in Chapter 13 bankruptcy plans. Some student borrowers now leave chapter 13 bankruptcy plans with more student debt than when they entered. More favorable treatment of student debt in bankruptcy could benefit both student borrowers and taxpayers.
Proposed Changes:
- Retain current rules governing access to Chapter 7 and Chapter 13 bankruptcy adopted in the 2005 Bankruptcy reform act.
- Change bankruptcy code to make private student loan debt dischargeable in bankruptcy.
- Provide priority to payments on federal student loan payments under chapter 13 bankruptcy plans.
Advantages
- Retention of means test for use of chapter 7 bankruptcy discourages bankruptcy filings for many people who might be able to pay off their debts without bankruptcy relief.
- Private student loans with high interest rates is similar to credit card debt and other consumer loans and should be treated accordingly.
- Helps people leaving chapter 13 bankruptcy obtain a fresh start.
- Helps taxpayers by increasing and speeding up student debt payments.
- Helps the most vulnerable student borrowers. Should reduce the number of older taxpayers having Social Security garnished because of unpaid student debt.
- Creates an incentive for lenders to better evaluate the ability of borrowers to repay private consumer loans and private student debt.