Income-Driven Repayment and Negotiated Rulemaking
Options for Consideration as Part of the Department of Education’s 2021 Process
Sept. 30, 2021
Income-driven repayment (IDR) plans, a suite of programs which aim to provide more affordable options by tying borrowers’ monthly payments to their incomes and family sizes, are critical tools for student loan borrowers. (More information on IDR can be found in these resources.)
Borrowers enrolled in IDR plans default at much lower rates than those in non-IDR plans and have access to loan discharge after 20-25 years’ worth of qualifying payments. However, despite significant improvements to program design and generosity over time, too many borrowers continue to struggle with repayment, even if they never default on their student loans, and many borrowers who might benefit from IDR are not enrolled.
The Current System Is Not Serving All Borrowers
The current IDR landscape is beset by administrative and structural challenges, including:
- Unaffordable payments: While IDR plans lower payments for many, under the current formula, IDR payments can still be too high for some borrowers, in part because they don’t take into account other aspects of family finances. For example, borrowers may also have private student loans, medical costs, or other expenses that are not factored into the income-driven payment calculation.
- Balance growth: While a lower income-driven payment can be more affordable month to month, many borrowers watch their balances grow under IDR if their payments do not cover the interest that accrues and capitalizes on their student loans. Although there is a light at the end of the tunnel—any debt that remains after 20-25 years (depending on the plan) of income-driven payments is discharged—the financial and psychological toll of making regular monthly payments far into the future while sitting on a ballooning debt balance can discourage engagement with the repayment system and lead to borrowers paying much more over the life of their loans.
- Lack of access: Many borrowers face barriers to enrolling and remaining enrolled in an IDR plan, due to confusing and burdensome administrative requirements and the complexity of the system. (For example, there are currently five different IDR plans, each with different eligibility requirements, costs, and benefits.) As a result, some borrowers who would benefit from an IDR plan are not using one. In addition, not all borrowers—including those who struggle most with repayment—have access to the program.
To address these challenges, the Department of Education (ED) is considering creating a new plan as part of its upcoming negotiated rulemaking process. In doing so, ED must:
- Ensure reforms are borrower- and equity-focused by explicitly considering and addressing the needs of underserved and under-resourced populations, including communities of color, student parents, those who do not complete a degree or credential, and veterans, among others. While some of the reasons why some borrowers struggle in repayment—including, but not limited to, systemic racism and labor market discrimination—can occur outside of the repayment system, the repayment system should account for and address known patterns of borrower distress. In particular, Black borrowers hold higher student loan balances and repayment burdens, are disproportionately harmed by student loan debt and existing IDR formulas, and are less likely to be paying down principal compared to White and Latinx borrowers.
- Address existing bureaucratic hurdles and broader design flaws to create an IDR plan that is easy to access, provides a truly affordable monthly payment, and ensures real relief after a reasonable number of payments.
- Build from the Revised Pay As You Earn (REPAYE) plan, which has no income requirements for enrollment and the most generous interest subsidies.
- Ensure new and revised plans are not only easy to access but also simpler to implement and administer.
Below is a discussion of multiple options for reform, including our recommendations.
Making IDR Plans More Affordable
There are a host of program design elements that can be adjusted to make IDR payments more affordable for borrowers. In addition to discussing each item, negotiators should pay attention to the entire package of reforms. An important goal must be ensuring that the final design for a new plan reduces monthly payments and total amount repaid for borrowers and is easy to understand and administer (even if some original elements remain unchanged).
Reduce borrowers’ monthly payments by adjusting the IDR formula. Multiple current plans, including the most recent REPAYE plan, limit borrowers’ monthly payments to 10 percent of their discretionary incomes. Various proposals—including one from President Biden—would reduce this number to as low as five percent, but other proposals retain or remain closer to the 10 percent figure.
Similarly, the current protected income threshold (separate from the discretionary income limit) needs to be raised above 150 percent of the poverty line. The existing threshold does not account for the varying costs of living in different communities, the cost of private education loans that many borrowers carry on top of federal student loans, and other individualized, often unpredictable expenses such as medical, child, and other dependent care. Some borrower advocates have called for the threshold to be raised to 250 percent for all borrowers, others have called for it to be set at 200 percent, and some have proposed that it be adjusted based on the presence and number of dependents. Regardless of the exact amount, there is consensus among advocates that the protected income threshold should be raised above its current level.
Reduce the repayment term for some or all borrowers. The current length of IDR repayment terms can disincentivize IDR uptake.
Under REPAYE, the different repayment terms for undergraduate (20 years’ worth of payments required for forgiveness) and graduate (25 years) borrowers create a cliff effect, where even a low level of graduate debt triggers a longer payback period. Moreover, interest accrual and graduate school debt contribute to Black graduates holding almost twice as much debt as their white peers four years after leaving school, raising equity concerns. This approach also creates complications for borrowers who would otherwise benefit from consolidating undergraduate and graduate loans.
To address these issues, the repayment term should not be tiered based on whether a borrower holds graduate loans. Some have suggested reducing the term to 15 years for all borrowers, while others have floated that forgiveness be tiered using other borrower characteristics. As with other design details, there are tradeoffs between simplicity and cliff effects, and additional data is needed to inform the discussion.
Options for calibrating the length of IDR repayment should include:
- Allow incremental forgiveness. Today, loan forgiveness as part of IDR is all-or-nothing. Rather than providing forgiveness of all unpaid balances after the end of the maximum repayment period, policymakers could consider providing incremental forgiveness. For example, a set amount or a percentage of a borrower’s balance could be forgiven for every certain number of years spent in repayment. This approach could also be combined with those listed below.
- Create a shorter time frame for low-balance or consistently low-income borrowers. Long repayment periods can dissuade low-balance, often low-income borrowers from using IDR, even if they would benefit from the lower monthly payments. Another approach would be to set a shorter forgiveness timeline for borrowers with balances under a set amount or with incomes under a certain threshold for an extended period of time; for example, grant forgiveness after 10 years of income-driven payments if a borrower owes less than $10,000 or if a borrower’s income never exceeds the poverty guidelines, protected income threshold, or another relevant metric.
- Calibrate the repayment period based on the amount borrowed. Another approach would be to calibrate a maximum payment length using the amount borrowed (e.g., three months of repayment for every $250 borrowed, capped at 20 years, where every $1,000 borrowed equals one year of repayment).
- Calibrate the repayment period based on degree completion. Policymakers could also consider setting different repayment periods or ongoing flat dollar forgiveness for borrowers who did not complete their degrees. Such approaches would allow those borrowers to retire their debt—which did not translate into increased earnings prospects—more quickly. Additional data to identify categories of borrowers who are unlikely to ever repay their loans would be helpful in evaluating these options.
- Count pre-consolidation payments. Currently, if borrowers consolidate their loans—for example, to access more generous repayment plans or exit default—the clock resets: any payments made toward forgiveness as part of an IDR plan pre-consolidation are no longer counted and a borrower’s IDR payment clock starts over. Negotiators should consider eliminating this practice to the extent possible via the negotiated rulemaking process.
- Establish a maximum time in repayment for certain loan statuses. Negotiators may wish to create language that forgives borrowers’ loans after they have spent more than a certain amount of time in repayment or in certain statuses. For example, borrowers who have spent more than a certain number of years in default could be given a fresh start.
- Maintain the alternative repayment plan. Current language allows for the creation of alternative payment arrangements for borrowers with extreme circumstances. Language developed through the negotiated rulemaking process should retain this important option for struggling borrowers.
- Ensure economic hardship deferments continue to count toward forgiveness. Time spent in economic hardship deferment should continue to count toward forgiveness for those enrolled in IDR plans.
In addition, time spent in existing IDR plans should count toward forgiveness for any newly created plan. Importantly, if a newly-created plan requires fewer payments before forgiveness is granted, borrowers who have been in an existing IDR plan for longer than the new repayment period should be immediately eligible for forgiveness.
Constraining Balance Growth for Borrowers in IDR
Eliminate negative amortization by fully subsidizing unpaid, accrued interest for all borrowers enrolled in IDR for the duration of their enrollment, regardless of loan type. Many borrowers in IDR (especially those with low or no incomes) are negatively amortizing, meaning their balances are growing over time due to interest accrual and capitalization. These ballooning loan balances can be distressing, can add costs for borrowers, and can dissuade borrowers from enrolling in IDR even if they would otherwise benefit from doing so. Negative amortization also disproportionately affects borrowers of color. Restraining the accrual of unpaid interest for borrowers with negatively amortizing loans is a targeted benefit that helps minimize the growth of loan balances for borrowers with low incomes relative to their debt.
Under REPAYE, for borrowers who hold subsidized loans and whose monthly payment amount is not sufficient to cover accruing interest, the federal government covers 100 percent of remaining interest that is due for the first three consecutive years of repayment. After the three-year period, the federal government subsidizes 50 percent of this unpaid, accrued interest, rather than all of it. For borrowers with unsubsidized loans, the federal government covers 50 percent of unpaid, accrued interest during all periods.
Under an improved IDR plan, we recommend that the federal government fully subsidize all unpaid, accrued interest for all borrowers for the full duration of repayment.
Other options to consider to restrain balance growth could include:
- A cap on accrued interest: Balance growth is not limited to borrowers enrolled in income-driven plans. Missing and pausing payments can also lead to balance growth. For these borrowers (including those who miss or pause payments while in an IDR plan) interest accrual could be capped monthly, or a total cap could be set at a certain percentage (e.g., 25 percent) of the total loan balance. However, this proposal will not help borrowers until they hit the cap, which, for those in IDR, may mean they could see a reduction only in the amount they have forgiven, not the total amount they end up paying.
- No interest accrual in certain statuses: Currently, interest accrues during a host of repayment statuses, notably economic hardship deferments (which count as payments toward IDR forgiveness) and default (which is not the case for many other consumer credit products). Negotiators should consider eliminating interest accrual in these statuses to match the interest subsidies proposed above for IDR and to ensure borrowers’ balances don’t spiral out of control while they are in default.
End all instances of interest capitalization. When capitalization occurs, the entirety of a borrower’s unpaid, accrued interest is added to the outstanding principal balance and begins accruing interest. As a result, borrowers may end up paying much more in total over a longer period or have larger amounts forgiven. The Department has publicly acknowledged that interest capitalization “serves no purpose, other than to generate additional interest income” and is a key reason why borrowers are confused about their loans and balances.
In all existing IDR plans and at other times throughout repayment, interest capitalization is triggered by different events—such as leaving deferments and forbearances, missing an IDR recertification deadline, and consolidating loans. Fully eliminating this interest capitalization for all borrowers, to the extent possible, would limit the growth of loan balances and greatly simplify communication with borrowers.
Make IDR benefits consistent. Some existing IDR plans cap monthly payments at the amount a borrower would have had to pay were they enrolled in a fixed 10-year plan (called the “permanent standard” amount). This results in some high-income borrowers paying a smaller share of their income than lower-income borrowers.
Eliminating the cap, as was done for REPAYE, means all IDR borrowers make monthly payments based on the same share of their incomes. While this means that those with higher incomes who opt into this plan may pay more on a monthly basis, this reform would result in them paying less over time and should be paired with dramatic increases to the overall generosity of the plans, as described above.
Also above, we suggest that those with lower balances and lower incomes be allowed to repay for less time. Negotiators may want to consider allowing these or other groups to pay smaller shares of their incomes.
In addition, not all existing IDR plans treat married borrowers equally: some plans require married borrowers to count a spouse’s income in the monthly payment calculation while others allow married borrowers who file taxes separately to have their spouse’s income excluded from the monthly payment calculation. A new plan should align with the existing REPAYE plan to ensure that, if married borrowers are given the option of not including spousal income as an asset in determining their monthly payment amount, they should also not be able to include their spouse in the family size calculation.
Improving Access to IDR Plans
Any new IDR plan should be available to all federal student loan borrowers, regardless of their debt or income level, whether their loans are Direct or FFEL program loans, when they borrowed, or their repayment status.
All student borrowers should be eligible, regardless of income. Some existing IDR plans require borrowers to demonstrate a “partial financial hardship” (PFH) for eligibility. Plans that require a PFH are available only to borrowers whose calculated payment based on income and family size is less than what they would pay under the fixed 10-year plan (i.e., borrowers with a high income-to-debt ratio).
Removing this eligibility requirement, as the existing REPAYE plan does, allows any borrower to make payments based on income, if they prefer. It also simplifies the process of selecting and enrolling in IDR because borrowers do not need to understand and satisfy the administrative requirements of demonstrating a qualifying debt-to-earnings level. Additionally, it simplifies the process for loan servicers, who do not need to calculate and track a borrower’s PFH status.
Defaulted borrowers should be eligible and IDR payments made by borrowers while in default should count toward forgiveness. Importantly, precedent exists for this reform: Both the Income-Based Repayment (IBR) and Income-Contingent Repayment (ICR)—two types of IDR plans—statutes permit borrowers in default to access IBR or ICR; the Department of Education’s regulations prohibit defaulted borrowers from using them.
The consequences of default are severe. Defaulted borrowers need an affordable repayment option, and involuntary collection tools often take a far higher share of resources from borrowers than those same borrowers would pay under an IDR plan. In addition, some borrowers are not eligible to get out of default. Allowing borrowers in default to access IDR could also streamline and reduce confusion between payment requirements in the repayment system and the default system. It is important to note, however, that a borrower’s IDR payments in default could be higher than the required payments under a rehabilitation agreement, one option for exiting default. (The default system is punitive, disproportionately harms low-income borrowers and communities of color, and is greatly in need of reform, but that topic was not included in the 2021 negotiated rulemaking process.)
Borrowers should be able to access any new IDR plan regardless of when they borrowed or whether they have federal Direct or FFEL program loans. To qualify for some existing IDR plans, borrowers must have taken out their first loan after a certain date, and that date varies between plans. These “new borrower” requirements are unnecessarily complicated and confusing. Also, several of the existing IDR plans are available for Direct Loans only, so borrowers wanting to repay FFEL program loans in those plans have to go through the extra step of consolidating into a Direct Loan first, which can also result in losing credit for pre-consolidation payments made toward forgiveness in an IBR plan.
Note: A host of groups have also advocated for Parent PLUS loan borrowers (Parent PLUS loans are made to eligible parents of undergraduate students) to be allowed to access all IDR options, including any new plan. Parent PLUS borrowers are currently only able to access ICR—the least generous of all the IDR plans—and only if they consolidate their loans. Negotiators should examine and consider these proposals. (In addition, broader change may be needed to ensure access while preventing default and negative outcomes, but those are outside the scope of this publication.)
Reducing Program Complexity
Make it easier to enroll and remain in IDR plans. Legislation passed in 2019, the FUTURE Act, enabled the IRS and ED to share tax data—with permission from the borrower—to automate the burdensome and often-confusing annual IDR recertification process, making it easier for borrowers to remain in the IDR program. The law did not set an effective date for its reforms, and today, the timeline for full implementation of the FUTURE Act is unclear. Importantly, while the law is being implemented, borrowers are still required to manually recertify their information each year. To assist borrowers with accessing IDR, especially given the economic downturn, ED should prioritize the implementation of the FUTURE Act, which can be done administratively.
But there is also a role for the regulatory process. Negotiators should ensure that any new IDR plans created via the rulemaking process take FUTURE Act implementation into account and establish robust and easy-to-use processes for those who cannot or prefer not to use this new automatic income verification (or whose financial situations have changed since their last tax return).
In addition, until the FUTURE Act is fully implemented, negotiators could create additional flexibilities to streamline IDR enrollment, such as temporarily permitting servicers to enroll borrowers into an IDR plan without requiring extensive paperwork—such as verbally, through a website, or through electronic communication. Importantly, this action would ensure borrowers have easier access to an IDR plan when the COVID-19-related emergency benefits end for student loans.
Streamline IDR plans. The variety of IDR plans—each with different eligibility requirements, costs, and benefits—can be confusing to borrowers and difficult for servicers to administer. The Department should work with lawmakers to address this complication.
One option would be to fully sunset all of the existing repayment plans except for a newly created or reformed plan, after a transition period. However, if any borrowers (potentially high-income borrowers) are asked to pay more under a new IDR plan than they are paying under an existing plan—even through a more generous plan, as described above—negotiators may opt to not sunset all existing plans (and there is not consensus on whether and how plans can be streamlined via the regulatory process).
If plans are not sunset or otherwise consolidated, borrowers could be given incentives, such as an interest rate reduction, to switch into the new plan. Importantly, negotiators should then also focus on removing the most confusing and complex pieces of the existing plans. For example, in some cases, borrowers changing from an income-based plan to another repayment plan must first make a (likely much higher) monthly payment under the standard repayment plan or be placed into forbearance for a month before they can access their new plan.
Importantly, borrowers should retain access to a fixed repayment plan, allowing borrowers to make consistent monthly payments over the life of the loan, which could lead to borrowers paying less over time than in certain IDR plans.
Working With Congress to Enact Statutory Changes
While these reforms can’t be addressed through the negotiated rulemaking process, they are necessary to strengthen the entire IDR “package.”
Automatically enroll severely delinquent borrowers in IDR to prevent default. While borrowers should have a choice between a fixed repayment option and an income-driven option, borrowers who are severely delinquent on their loans should be automatically enrolled in income-driven repayment to help them avoid the severe consequences of default.
While IDR is not right for everyone, it is always preferable to default, and IDR payments can be as little as $0 for borrowers with very low incomes. Borrowers should be notified that they will be enrolled in IDR if they do not act; they should be given the opportunity to opt out before a set deadline.
In addition, as part of the implementation of the FUTURE Act, ED could allow borrowers, before they leave school, to opt into having their data shared between ED and the IRS. This early consent would give servicers the flexibility, once borrowers enter repayment, to notify those who are not in an IDR plan what their potential IDR payments would be if they were to enroll. It would also allow borrowers to give permission to be automatically enrolled into an IDR plan if they fall behind on their payments.
End taxation of all forgiven debt. Currently, the IRS does not consider as taxable income loan balances discharged after 10 years of payments under the Public Service Loan Forgiveness program or because of death or permanent disability. In March 2021, Congress passed a law to temporarily eliminate the taxation on all forgiven student debt, regardless of the reason. This provision extends through the end of 2025. The Department should work with lawmakers to make this exemption permanent for all types of forgiven student debt.
Forgiven debt is not income and should not be taxed. Student borrowers should not be hit with a tax bill after making responsible payments for many years, particularly since the borrowers who end up receiving loan forgiveness will be those with low incomes relative to their debt for a long period of time. It serves no policy goal for the government-as-lender to forgive debt so that a borrower may move on only to have the government-as-tax-collector immediately demand further payment.
Making Additional Data Available on How Borrowers Navigate the Repayment Process
Publicly available data on how borrowers navigate student loan repayment is scarce, making it difficult for policymakers and other stakeholders to make evidence-based assessments of what works best to keep borrowers on track and out of default and trade-offs that could be made in designing reforms.
For example, while quarterly snapshots of the status of the federal student loan portfolio are available in the Federal Student Aid Data Center, these data are not disaggregated and do not provide a full picture of the challenges borrowers face in repayment. And researchers are not permitted to access microdata from the National Student Loan Data System (NSLDS)—the database that tracks the status of federal student loans.
Negotiators, where possible, should consider releasing existing data to help policymakers, researchers, advocates, and practitioners assess the state of the student loan portfolio, provide recommendations for data-driven reforms, and conduct equity audits on departmental processes and outcomes.
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