Additional Student Loans For Living Expenses – A side note in President Biden’s announcement of roughly half a trillion dollars in student loan forgiveness are his proposed changes to Income Driven Repayment (IDR) plans that will take effect in January 2023. These changes mean that most undergraduate borrowers will only expect to pay back a portion of the amount they borrowed, partially converting student loans into grants. It’s a plan to lower the cost of a college education, not by cutting tuition, but by giving students loans and giving them the option of not paying them back. In the absence of congressional action, Biden has no other obvious policy levers to lower college costs. But using government loans to subsidize college has important drawbacks and will have unintended and harmful effects on borrowing, student success, higher education costs, home equity, and the federal budget.
The proposed plan is significantly more generous than the existing IDR plans. Undergraduate borrowers will pay 5% of any income (up from 10% now) if they earn more than $33,000 a year (225% of the poverty line, up from 150%). If the payments are not enough to cover the monthly interest, the government will forgive the remaining interest so that the balance does not increase. All remaining loans will be forgiven after 20 years (or 10 years under the Public Service Loan Forgiveness Program and for borrowers borrowing $12,000 or less). Borrowers with graduate debt are expected to benefit from all of the above, as well as be more generous with all student loans. The Department will automatically enroll or re-enroll certain students in the plan if they have authorized the use of their income information.
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These parameters mean that the vast majority of students (roughly 85% of students aged 25 to 34) will be eligible for concessional payments if they take out student loans, and most undergraduate borrowers (perhaps 70%) expect to have at least some debt forgiven after 20 years. On average, borrowers (current and prospective) can expect to get back roughly $0.50 for every dollar they borrow. Again, this is an average; many borrowers can expect to never default on their loan, while others must expect to pay off the loan in full.
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(These numbers are uncertain because estimating such results requires a detailed model to predict future payments, as well as data on debt levels and borrower incomes that are not currently available. However, it is clear that the subsidies will be widespread and substantial.)
This represents a radical change in student lending. In recent years, the Congressional Budget Office has come to expect this
A student loan borrower must pay more than $1 for every $1 they borrow (because the government charges interest on the loans). Historically, this has made loans a less attractive way to pay tuition. But under the new plan, loans will be the preferred option for most students, by and large. Get a 50% discount on tuition! But only if you pay with a federal loan because you don’t have to pay it all back.
The administration’s plan will be subject to public comment before it is implemented. There are several ways in which this could have significant, unforeseen, negative consequences.
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Unfortunately, all the negative effects of the IDR proposal stem from its generosity – the fact that almost all borrowers will be required to repay only a fraction of the amounts borrowed.
Indeed, given the current structure of federal loan programs, there is no consistent way to subsidize colleges with loans that are expected to be largely forgiven as envisioned in the IDR proposal. In a sequential system, Congress would change the law to read:
Only with the above elements can an IDR policy function as intended: as an income-neutral insurance policy that expects the average borrower to repay their loan (eventually with interest), but provides relief to unlucky borrowers during periods of lower incomes and forgiveness for people in permanent disadvantage position. A harmonized system cannot be created at the behest of regulatory authorities. Congress must act.
According to the Department of Education (NPSAS 2016), undergraduate students borrowed about $48 billion in 2016. However, that year borrowers were eligible (based on federal credit limits and unmet financial need) to receive an additional $105 billion in federal Stafford funds. loans. Only 40% of dependent students took out a student loan in 2016; The 60% who couldn’t borrow $35 billion but chose not to. Dependents with loans were running out, but they were still able to borrow another $3 billion. Similarly, independent borrowers (those not supported by their parents) could borrow an additional $11 billion. And independent students who didn’t take out loans (two-thirds of independent students) were able to take out loans worth up to $56 billion. PhD students borrowed $34 billion; they could borrow another $79 billion. In other words, in 2016, students borrowed only 31% of the amount they were eligible to borrow ($82 billion out of $266 billion).
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It is clear that many students did not take on debt because they or their parents paid for college in other ways. Some borrowed for tuition, but not for non-tuition related expenses (living expenses). Some were eligible for the loan despite not needing the funds because their costs were paid through Geographic Information Act or other sources disregarded for Title IV assistance. But such students are entitled to a loan and can take it if they want. (Even if the GI Bill covers all of your tuition and living expenses, you’re still eligible to take out loans to cover those same expenses.)
In the past, it was logical for students to keep borrowing to a minimum in most cases. Back in 2017, the CBO projected that student loan borrowers would pay back an average of about $1.11 per dollar they borrowed (including interest). A loan was often considered the least cost-effective way to pay tuition.
But under the administration’s proposed IDRs (and other regulatory changes), undergraduate borrowers who enroll in the plan can be expected to pay roughly $0.50 for every $1 borrowed, and some can safely expect zero repayment. As a result, loans will be the best way to pay for your college education.
If there’s a chance you won’t need to pay off the entire loan—and it’s likely that most undergraduate students will be in that boat—it won’t be financially difficult to take out the largest student loan. Even borrowers who expect to pay off their loan will benefit from subsidized interest rates that apply to paying less than the full amount. (For example, because the IDR is based on information from your most recent available tax return, any student who earned less than 225% of the poverty line at the time of enrollment would not have to make payments for the first one or two years after graduation and thus take advantage of the automatic interest-free loan for one or two years.)
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Most borrowers will benefit from the potential subsidy. The chart below shows the share of Americans ages 25 to 34 with at least some college experience who could benefit from reduced payments under an IDR policy. The X-axis is income. The y-os represents the proportion of each group of students (those with some college experience but no degrees, those with an AA degree, and those with a bachelor’s degree or higher) whose income is below each income level. For example, the chart shows that about 40% of recent college graduates between the ages of 25 and 34 earn less than $40,000, but about 60% of AA degree holders earn less than that amount.
The first vertical red line indicates the IDR threshold below which borrowers will make zero payments. The second vertical red line indicates the threshold at which the IDR payment is equal to the standard payment for 10 years (assuming average undergraduate student debt to graduate student debt). In other words, the second vertical line indicates the point at which the borrower no longer benefits from the reduced payment under the IDR proposal.
Data shows that about half of Americans with some college experience but no bachelor’s degree can qualify for zero payments under this offer, as do about 25% of college graduates. However, the vast majority of students (including more than 80% of bachelor’s degree recipients) may qualify for tuition relief.[1]
These reduced payments will result in significant forgiveness. While the amounts are unclear given the specific parameters of this proposal, in an earlier paper, Urban Institute economist Sandy Baum estimated potential forgiveness under alternative IDR parameters that are more generous than existing IDR policies, but nowhere near as generous as the IDR. now proposed plans. For example, in a scenario where undergraduate borrowers pay 5% of income above 150% of poverty and no interest subsidy, only half of the borrowers will repay a $30,000 loan (which is close to the average undergraduate loan balance). According to the new proposal, the share in loan repayment will be drastically reduced because the threshold is higher and the interest repayment is subsidized. I assume that approximately 70% of borrowers can expect a possible write-off of their loans under the new rule. On a net present value basis (which is an appropriate method for estimating the cost of subsidizing loans), it seems likely that
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