The The concept of student loan cancellation has held the attention of politicians and those involved in higher education policy for more than a year. Despite the popularity of this extremely regressive idea, it is terrible. Fortunately, there is a better, more moderate way to tackle federal student debt. And he hides in plain sight.
Income-Based Repayment (IDR), an existing set of programs that perform somewhat poorly, can be improved to ensure that no borrower will ever have to make an unaffordable payment on federal student loans. Under IDR, monthly payments are tied to the borrower’s income and unaffordable balances are eventually written off. The IDR does this in a way that minimizes moral hazard and delivers benefits in a truly progressive way – with more benefits for people who have invested in a college degree and have taken on debt to do so, but did not see the return they were promised in the form of a well-paying job. The IDR also makes college more accessible to children from low-income families, thus allowing higher education to function as a mechanism for social mobility.
The monthly payments for conventional loans are determined at the outset, with repayment of principal and interest spread over a defined period of time. In contrast, IDR allows borrowers to make monthly payments equal to a fixed percentage of their current disposable income. When income is high, they pay the full amount owed, and when income is low, they can make a reduced payment without penalty. This ensures that the monthly payments are affordable. The balance is written off once the borrower has made the required number of IDR payments. It takes between ten and 25 years depending on the student’s eligibility and the choice of IDR program. Borrowers may not like having a balance hanging over their heads for so long, but the reduced monthly payments (often reduced to zero) mean the process isn’t overly cumbersome.
By reserving benefits for those who really need them, the IDR mechanism also reduces the perversion of incentives that often accompany the implementation of safety nets. A less targeted aid program, like the proposed student loan exemption, would likely encourage prospective students to borrow more than they otherwise would have, attend more expensive schools, and make less effort to limit living expenses (also paid with loans). It would also fuel hopes of another round of policy-backed loan cancellations. Taxpayers, who ultimately pay the price for these programs, are left with even more costs. Colleges and universities would in turn raise prices to meet rising demand, exacerbating the already out of control inflation in the higher education sector.
Some might wonder if a safety net for student borrowers is really necessary. But if we want more Americans to use our higher education system, which includes both vocational and degree programs, we need to minimize the financial risk students face. While investing in higher education typically pays huge dividends, degrees don’t always lead to high incomes that would justify the cost. Students who start school but don’t finish are the worst off, as they end up with a large loan balance to repay without having access to income levels that would make repayment affordable. Without a safety net, it is still not really affordable for students from low-income families to go to university. Providing relief through a safety net allows for a more efficient allocation of resources, as benefits do not need to flow to those who invest in college and end up with a lucrative career.
Despite the relevance of the IDR system to the political challenge at hand, the system has not worked well. This is largely because IDR is administered through a variety of programs, each with different eligibility criteria and a range of program parameters. The amount borrowers are expected to pay is calculated differently from program to program, as is the number of years before borrowers are eligible to have their balance canceled. The result is a system that is excessively complex to navigate, with many borrowers unaware of the benefits available to them. While IDR is now universal for all federal student borrowers, it only became so after a series of legislative and executive interventions, between 1992 and 2015, bringing together a patchwork of loosely linked programs. The factual evidence for how IDR has been used is limited, but anecdotes about the challenges of navigating the system, even by financially savvy consumers, point to systemic problems. This shaky political framework desperately needs to be replaced with a single, user-friendly, revenue-driven repayment plan that can be universally marketed and better understood.
Reasonable people may disagree with the generosity of the IDR. Moving the conversation away from the massive loan cancellation to the IDR reform would be a step in a fairer and more effective direction.
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