Potential Modifications to Student Loans


The current cohort of students is entering the workforce with substantially more debt than the previous cohorts of student and the growth of both the number of people with student debt and the average debt level have been consistently upwards. High student debt burdens are leading many student borrowers to forgo saving for retirement, delay starting a family, or put off purchasing a home.  

Some Democrats have urged President Biden to cancel up to $50,000 in student debt for all people with student loans.  Most economists believe that a widespread cancellation of student debt would be an inefficient and regressive subsidy.  Many student borrowers with debt could repay their loan without financial assistance and an indiscriminate loan relief program would allocate resources away from other pressing concerns. Most economic analysis supports the view that indiscriminate student debt cancellation programs would do very little to stimulate the economy.

Several papers including one by the New America Foundation one discussed in Inside Higher Education and my own work published by NASFAA have focused on reforming Income Driven Repayment Plans.  Current Income Driven Repayment (IDR) programs offering debt relief and linking debt payments to income have many problems.

  • The programs may incentivize some students to increase the amount they borrow.
  • Some students that commit themselves to an income linked loan may have been better off with a traditional loan.
  • Some student borrowers enrolled in IDR programs struggle to meet other financial priorities despite the benefits of the programs.
  • A large portion of applications for loan discharge have been rejected by the Department of Education as discussed in this CNBC article.

The memo presented here discusses ways to provide meaningful debt relief through modification of standard loan agreements instead of expansion of IDR loans or the creation of indiscriminate loan discharges.

A Proposal:

  • Discharge 40 percent of the initial loan balance after receipt of 60 monthly payments on 10-year loans and 72 monthly payments on 20-year loans.
  • Encourage partial interest payments for people in economic hardship rather than total payment forbearance.
  • Eliminate Interest charges on all loans on the scheduled loan maturity date.
  • Allow and facilitate collection of outstanding student loans after maturity of the loan by the IRs through federal tax returns.

Benefits of the Proposal:

The proposal presented here eliminates many of the uncertainties and problems associated with current programs offering student borrowers debt relief.    It offers students some assistance early in their careers allowing households to save for other priorities.   It does not create an incentive for students to increase the amount they borrow and contains incentives to facilitate quicker repayment of student debt.  The partial discharge of debt and the elimination of interest charges should reduce the number of people entering retirement with outstanding student debt.

  • The current system does not provide any loan forgiveness for 10 or 20 years.  The earlier debt relief in this proposal allows borrowers to pursue other financial objectives and may facilitate refinancing to lower-interest rate loans.
  • Many borrowers are unaware of any problems with their loan for 10 or 20 years when they apply for loan forgiveness.  The revised program will uncover problems with loan forgiveness applications after 60 months of payments for 10-year loans and 72 months of payments for 20-year loans.
  • The current system incentivizes many borrowers to pick the IDR program as soon as they leave school even though this choice can lead to higher lifetime loan payments if circumstances change.   The revised program assists borrowers with standard loans reducing reliance on IDR loans.
  • IDR plans create an incentive for some people to borrow more than they otherwise would because they anticipate low life-time loan payments and complete loan forgiveness. The alternative loan forgiveness terms presented here will always result in higher repayments for people who borrow more.
  • The loan discharge offered in this program occurs earlier for people making all payments on time, creating an incentive for student borrowers to prioritize student loan payments early in their career.
  • The existence of financial assistance for student borrowers with 10-year loans will reduce an incentive for borrowers to take out long-term loans and will speed repayment to the Treasury.
  • One study found the number of American over 60 with outstanding student debt quadrupled between 2005 and 2015. The elimination of interest charges at loan maturity proposed here should reverse this trend.
  • The elimination of all interest at the loan maturity creates an incentive for borrowers to allocate payments to other debts charging interest.  This problem is mitigated by requiring a minimum payment on student debt outstanding after the loan matures collected by the IRS through the federal tax return.

Concluding Thoughts:

Student debt is creating financial hardships for many borrowers and existing IDR programs often fail to provide meaningful debt relief.  Problems associated with student debt will worsen because of the growth of debt.  Most student borrowers can repay and manage their student debt with limited financial assistance.  An indiscriminate large discharge of student debt would impose costs on taxpayers and divert funds from other pressing priorities.

The program outlined here provides limited quick and efficient debt relief to student borrowers without the distortions caused by existing programs or proposed large-scale debt discharge proposals.

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