The Biden Administration responded to the Supreme court ruling disallowing student loan forgiveness by announcing a new Income Driven Repayment Plan (called the SAVE plan) and by facilitating discharges of existing IDR loan applications, through a modification of the count of previous payments.
This memo summarizes and evaluates these Biden Administration student debt initiatives and discusses alternative relief measures.
Biden Administration Student Debt Initiatives:
The SAVE PLAN described here replaces the REPAYE plan. Some features of the SAVE plan are implemented in the summer of 2003. Other features are scheduled to be implemented in July 2024.
These three features of the SAVE plan will be implemented this summer.
- Increase in the amount protected from payment obligation from income less than 150 percent FPL to income less than 225 percent FPL.
- Elimination of interest charges when monthly payment does not cover monthly interest charge.
- The elimination of spouse’s earnings in calculation of SAVE payment.
- The exclusion of spouse in household size in calculation of protected income threshold.
Additional reductions in monthly and lifetime payments under the SAVE plan are scheduled to be implemented in July 2024.
- Reduction in monthly payment of undergraduate loan from 10 percent to 5 percent of income. Borrowers with both undergraduate and graduate loans will pay a weighted average of 5.0 percent and 10.0 percent.
- Reduction in the number of years for loan discharge based on the amount borrowed. Current requirement for loan discharge for IDR borrowers is 20 or 25 years of repayment. The SAVE requirements are 10 years for initial loan balance less than $12,000 and a 1- year increase for every additional $1,000 in the initial amount borrowed.
Currently, relatively few IDR borrowers receive a loan discharge as scheduled. The SAVE rule includes new procedures designed to reduce pitfalls preventing loan discharges. These new procedures include:
- Automatic enrollment for people who provide access to federal tax returns even without payment within 75 days.
- Access to IDR program for some borrowers in default.
- IDR credit for some borrowers in deferment but additional payments for some other borrowers in deferment.
- Some credits for borrowers in deferment.
These Biden Administration is also attempting to facilitate more existing IDR loan discharges by fixing the count of past payments on IDR loans as discussed here. The Department of Education announce of the program adjusting IDR payment counts states:
“These fixes are part of the Department’s commitment to address historical failures in the administration of the Federal student loan program in which qualifying payments made under IDR plans that should have moved borrowers closer to forgiveness were not accounted for. Borrowers are eligible for forgiveness if they have accumulated the equivalent of either 20 or 25 years of qualifying months.”
The proposed adjustment to IDR payment counts includes increase credit regardless payments plan, or existence of forbearance or deferment. The Biden Administration projects that this initiative will provide relief to 804,000 IDR borrowers.
Evaluation of the Student Debt Initiatives:
The Department of Education claims SAVE will provide borrowers with substantial savings including:
- A reduction in total payments of 40 percent.
- A savings of $2,000 per year for a typical graduate from a four-year institution.
- A 2/3 or $17,000 reduction in total payments for a teacher using the public service loan forgiveness program.
- An 85 percent debt free rate within 10 years for community college borrowers.
- An average 50 percent reduction in total payments for Black, Hispanic, American Indian, and Native American borrowers.
Some aspects of the SAVE program are useful. The new SAVE subsidy on interest payments when the borrower’s monthly payment does not cover interest costs will reduce costs for some borrowers.
However, the SAVE modifications do not alter basic inefficiencies with IDR loans.
The Department of Education vastly overstates likely long-term savings from the replacement of the REPAYE program with the SAVE program.
Even with the SAVE modifications many applicants choosing the IDR loan will either pay substantially more over the lifetime of the loan than under a standard repayment plan, will pay higher taxes because of their use of the IDR option, will not receive an on-time loan discharge, or may be forced to convert to a standard repayment plan.
The SAVE program does not alter the fact that changes in earnings and changes in marital status create substantial uncertainty about the cost of IDR loans.
The decision to enter the IDR program or accept a standard 10-year or 20-year repayment plan is typically made as soon as the student borrower leaves school. Often the applicant is single and earning a low salary. Often the IDR program provides the only affordable payment option immediately after leaving school.
The existence of the IDR option prevents many people entering the workforce from quickly defaulting on their student debt. Unfortunately, many of the people choosing the IDR option, because other options are not feasible will pay much more in student loans or in taxes over the life of their loan.
IDR loan payments increase substantially if income rises and/or if the person marries. The SAVE program reduces but does not eliminate some problems caused by uncertain household income and changes in marital status.
The SAVE provision eliminating the spouse’s income in the loan payment formula for people filing separate returns will decrease loan payments for married couples filing separate returns. However, the lower loan payment from the new rule will often be offset and could be smaller than the increased tax obligation from filing separately instead of filing jointly.
A decision to file married separately instead of filing married jointly will increase tax obligations for the vast majority of married couples, as explained here. Features of the tax code leading to this result include:
- A substantially higher tax rate for separate returns than joint returns,
- 50 percent reduction in exemption for the alternative minimum tax,
- Loss of credits and benefits for child and dependent care expenses,
- Loss of the earned income credit,
- Loss of exclusion and credits for adoption,
- Loss of education credits and deductions, including the deduction for interest on student debt,
- Loss of exclusion on interest for savings bonds used for education,
- Potential loss of elderly tax credit or income exclusion for Social Security,
- 50 percent reduction in child tax credit, retirement savings contribution, and capital loss deduction,
- Loss of standard deduction when spouse itemizes,
There is something a bit ironic in the fact that people who decide to file separate returns to take advantage of the lower IDR loan payments could lose other education related tax benefits including the deduction of the interest on their student debt and the exclusion of tax on savings bond interest used for education expenses.
Typically, the IDR option is the only viable option for student borrowers entering the workforce because starting salaries are low. Typically, the student borrower is single when starting repayment. The potential problem associated with the choice between married filing jointly and married filing separately does not arise until the wedding.
The married couple that chooses to file married separately instead of married jointly to obtain a lower student debt payment, would be subject to higher marginal and average tax rates, lose several tax deductions and credits, and pay a higher alternative minimum tax. Most married students will choose to file joint returns and will lose the lower IDR payment and the opportunity for a loan discharge.
The projected benefits of the SAVE program offered by the Biden administration do not include the projection of a reduction in loan discharges from people who refinance their IDR loan due to increased tax obligations from changes in their marital status.
The new rules on counting previous IDR payments and the SAVE rules designed to eliminate pitfalls preventing on-time loan discharges will prove ineffective.
Current IDR programs have failed to provide timely debt discharges. The existing evidence on the effectiveness of IDR loan comes from the Public Service Loan Forgiveness Loans (PSLF), which are tied to IDR loans. Go here for some statistics.
- Around 2.15 percent of Public Service Loan Forgiveness applications processed since November 2020, were accepted.
- Only around 6.7 percent of eligible student borrowers applied for loan forgiveness.
- Around 30 percent of denied claims are due to incomplete paperwork.
There is a lot of room for improvement. Even if the SAVE rule changes and the one-time adjustment previous IDR payment counts to lead to a large improvement in on-time loan discharges, the overwhelming majority of borrowers applying for a loan discharge will be denied.
The recent announcement is not the first announced attempt of a programs to facilitate more accurate counting of IDR loan payments.
Legislation mentioned here was enacted in 2019.
President Biden announced a previous “one-time” PSLF waiver and “one-time” IDR waiver. The PSLF waiver lasted from October 2021 to October 2022 and the IDR waiver time frame was originally April 2022 to December 2023. The previously announced IDR waiver described here looks identical to the one announced yesterday.
The Biden Administration claims that their new procedures will benefit over 800,000 borrowers needs to be taken with a bit of salt. Why weren’t these borrowers already assisted by the previous one-time waiver program.
An announcement of a plan to forgive student debt is different from an announcement that student debt has been forgiven.
It would be useful to have real time information on the percent of on-time IDR loan discharges.
IDR programs require substantial paperwork including initial enrollment and annual income and household certification requirements. Sloppiness by both borrowers and loan servicers has led to the low loan-discharge success rate.
Many student borrowers are not highly meticulous about their finances especially when starting their careers.
A CFPB report found that Borrowers report that servicers delay or deny access to loan forgiveness through wrong information about their loans, flawed payment processing, and bungled job certifications.
Servicers do not have an incentive to facilitate easy on-line enrollment because they can make more money when the student borrower is slow to repay her loan.
It is difficult to audit IDR loans, since many people with low income have a zero payment, which is identical to the payment they were improperly enrolled.
Neither the “one-time” IDR payment adjustments nor the replacement of REPAYE with SAVE alters the dependence on accurate reporting by households and loan servicers.
The proponents of SAVE can argue that their reforms will improve loan discharge rates.
Conveniently, there will be no real evidence on this point for at least 11 years.
The SAVE program fails to reduce the amount of time for possible loan discharge for the typical student borrower completing a four-year degree program.
The loan discharge program will have a miniscule impact on the date of discharge for most four-year students. A person with the average four-year degree debt level of $28,400 will not be eligible for debt discharge until 20 or 25 years after loan repayment begins.
The SAVE program, like other IDR loans creates unusual incentives impacting the amount borrowed and hours worked.
In some cases, a person with IDR loans could increase the amount they borrow without increasing the amount they pay back. This would occur when a student correctly anticipates low future earnings leading to both low loan payments and a loan discharge. IDR loans could, therefore, encourage increased borrowing by students in fields with low earnings.
The new SAVE discharge formula will likely deter some people who complete a two-year community college program from pursuing a four-year degree. The person with a two-year degree likely has less than $12,000 in debt and could realize a debt discharge after 10 years. This relief would be lost if the person returns to school and take on additional debt, since under SAVE it would take the student with an average four-year debt level 20 or 25 years to become eligible for a debt discharge.
All IDR loan programs, by linking student loan payments with income, reduce funds for consumption from additional work. The ACA premium tax credit and the progressive income tax also reduce gains from additional work. The SAVE program reduces but does not eliminate this penalty on additional work. (The SAVE program reduces the increase in loan payments from an increase in income from 10 percent to 5 percent.)
Conclusion of the IDR and SAVE evaluation:
IDR programs create financial uncertainty and are inefficient.
IDR programs do a good job in facilitating on-time payments by overextended student early in the repayment period of their loan.
However, IDR loans have not historically been discharged on time and many IDR borrowers end up paying far more over the life of the loan, in both loan costs and taxes, than borrowers who enroll in standard repayment plans.
The SAVE reforms do not alter many of the basic problems associated with IDR lending.
Alternative Approaches:
Modifications of the standard student loan contract:
Three changes to current standard student loan contracts would more efficiently assist overextended student borrowers than IDR loans.
- Elimination of interest rate for first three years on all student loans.
- Elimination of all interest rate on student debt contracts upon the maturity of the student loan.
- Convert any unpaid student loan balance to a tax obligation collected over 5 years.
Comments on proposed changes to the standard loan contract:
Comment One: The elimination of interest charges in the first three years after initiation of repayment reduces payments at the start of the repayment process when income is typically low.
- The elimination of a 5.0 percent interest rate on a 10-year $20,000 student loan reduces monthly payments from $212 to $167.
- The elimination of the interest charge on a $20,000 20-year loan reduces monthly interest payments from $133 to $83.
Comment Two: When interest rates are zero, the entire monthly payment is applied towards reduction of the loan balance. The quicker reduction in the loan balance allows student borrowers to concentrate on other financial priorities, like saving for retirement or purchasing a home, at an earlier date. This improvement in saving opportunities for the new generation is essential to offset likely reductions in future Social Security benefits.
Comment Three: The early interest subsidy and reduction in the loan balance facilitates, or at least does not discourage, additional study at a four-year institution by people who complete a two-year degree. By contrast, the SAVE applicant with a two-year degree will likely lose all chance of a loan discharge after 10 years by returning to school and taking on more debt.
Comment Four: The provision ending interest charges upon the maturity of the student loan will assist borrowers who are most likely to enter retirement and have their student loans garnished.
Comment Five: Under the interest rate concessions proposed here, people who choose to borrow more will repay more than people who choose to borrow less. This is not always true for IDR loan programs. The SAVE program could increase the tendency for some student borrowers who anticipate low lifetime earnings to increase the amount they borrow.
Comment Six: The conversion of the loan to a tax obligation when interest charges are eliminated at the maturity of the loan is needed to incentivize continued loan payments in the absence of interest charges.
Modification of IDR loan contracts:
IDR loan contracts could also be modified to reduce reporting problems and increase the likelihood of at least a partial loan discharge.
- The IDR loan should require a small monthly payment even if the required payment under the IDR formula is zero.
- The IDR loan contract should provide for partial loan discharges, around 10 percent of the outstanding loan balance, starting with the completion of 24 payments.
- An additional loan discharge of this amount would be granted after the completion of each round of 24 on-time payments.
- The total amount of the loan discharged due to the repeated partial discharges should not exceed more than 50 percent of the initial loan balance.
- Require loan servicers create an easy on-line portal for annual updates of income and household size.
Comment One: A zero IDR payment for a person with a zero IDR bill due to low income or forbearance is indistinguishable from a zero payment from a person who is avoiding all student loan payments. The requirement that all people in repayment make at least a small non-zero monthly payment creates an audit trail that separates people who are attempting to pay from people avoiding their obligation. The nominal payment would be applied both to people with a zero-payment obligation and people in forbearance.
Comment Two: Early partial discharges will force the loan servicers and the borrower to remove pitfalls from discharge earlier rather than later, when a fix may be extremely difficult.
Comment Three: A partial rather than a full discharge and the limitation of the total amount discharged to no more than 50 percent of the initial loan balances eliminates situations where IDR borrowers could borrow more without repaying more.
Comment Four: Improvements in technology should facilitate greater on-time payments and fewer reporting errors. However, these improvements may not be automatically adopted by loan servicers who often gain financially when borrowers fall behind.
Concluding Thought: Existing IDR loan programs create substantial financial uncertainty for borrowers and are highly inefficient.
IDR options provide borrowers with a feasible initial payment when they are starting their career at a low salary. However, often IDR borrowers will fail to receive potential debt discharges and will pay far more both on their loan and on taxes over their lifetimes due to the selection of the IDR option.
IDR loans are in some respects similar to mortgages with teaser rates. In the case of IDR loans, the initially affordable loan payment is followed by both higher loan payments and higher taxes.
The Biden Administration has exaggerated the potential benefits from the SAVE option, especially the likely reduction in lifetime student debt burdens.
The modifications to standard and IDR loan contracts proposed here will give a better outcome for student borrowers and taxpayers than the SAVE approach.
Student borrowers could also be assisted through changes in the bankruptcy code.
Other aspects of the student debt problem involve both the spiraling increase in tuition, living costs, and the amount of student debt incurred by the typical borrower.
Additional discussions on proposals to assist overextended student borrowers, proposals to reduce the amount borrowed, and proposals to control college costs can be found here.
The author of this post has also written A 2024 Health Care Reform Proposal found at SellWire and at Kindle.