The sensational media coverage about college graduates suffering under mountains of debt often ignores a crucial fact: safety nets already exist for many borrowers facing unaffordable monthly payments. For the last few years, borrowers of federal loans have been able to reduce their payments to 10-15 percent of their monthly disposable income. After 20-25 years, any remaining balance is forgiven. And for borrowers working in the public and non-profit sectors, forgiveness comes after 10 years.
These income-based repayment programs are now receiving increased attention for several reasons. The Obama administration has undertaken efforts to increase borrower awareness of their repayment options so that they do not default on their loans when they could be eligible for lower payments. At the same time, proposals have been made to fix design flaws of these programs, such as the huge tax bills that may be sent to recipients of loan forgiveness. President Obama's 2015 budget proposal includes several such changes.
These programs form an important safety net for student borrowers, and may even increase college access for students who are hesitant to take on debt to pay for their college education. But the costs of increased participation in these programs have the potential to threaten their long-term sustainability. In our new report, "Student Loan Safety Nets: Estimating the Costs and Benefits of Income-Based Repayment," we provide new empirical evidence on this issue by applying simulation methods to a nationally representative group of bachelor's degree recipients with student loan debt.
The main finding is that the significant costs of income-based repayment programs are not necessary to accomplish the core purpose of protecting struggling borrowers. The cost of allowing borrowers to pay off their loans over a longer period of time based on their income accounts for only one-quarter to one-third of overall program costs. The cost of forgiving remaining debt after a set period of participation in income-based repayment, on the other hand, accounts for half of overall program costs. The majority of costs, including those imposed by forgiveness provisions, surely have value to those who receive them, but are largely superfluous to the core mission of the programs.
The perverse incentives that loan forgiveness creates are even more worrisome than the unnecessary cost. Programs that reduce the risk faced by borrowers can have the unintended effect of encouraging students to take on more debt, perhaps by going to more expensive colleges, potentially contributing to rising college prices for everyone. The way to reduce this "moral hazard" is to decrease the generosity of the benefit, such as by eliminating benefits that are not essential to the core mission of the program. Forgiveness is a prime candidate because it is not critical to providing a safety net that protects borrowers from unaffordable loan payments.
We recommend that Congress revise the existing income-based repayment programs to eliminate forgiveness, or at least significantly reduce its generosity. If policymakers wish to encourage college graduates to work in the public- and non-profit sectors, they should replace the Public Service Loan Forgiveness Program with a more efficient and equitable program for subsidizing the wages of individuals in these sectors of the economy. There are surely public servants who worked their way through low-cost institutions who are just as deserving of support as are graduates of expensive colleges who took on large amounts of debt.
Students are borrowing much more to attend college than their parents did, in large part due to the fact that colleges are charging much more than they did a generation ago. The benefits of a college education have kept pace with those costs on average, but not all borrowers immediately reap those rewards, especially in hard economic times. The existing set of poorly designed student loan safety nets is surely better than none at all, but paring back these programs to their core purpose would put them on a more sustainable path that is fairer to all students.