Just the Tip of the Iceberg: Federal Student Loan Reform

With the college academic year approaching, the July 1st doubling in student loan interest rates couldn’t have come at a worse time. Even with low rates on subsidized student loans, lending is big business for the Federal Government. In 2012, the government earned $51 billion from student loans, more than any corporation’s annual earnings. As such, with the jump in interest rates, it is projected that profits will increase an additional $21 billion if nothing is done.  That would mean further deficit reduction, but a heavier burden on student borrowers in the future.

While the student loan interest rates did double, not all hope is lost. To amend this situation, a bipartisan plan was crafted by Senate leadership to retroactively change interest rates and terms. The bipartisan language (H.R. 1911), which has now been approved by both the House and Senate, bears far more semblances to an earlier Senate bipartisan plan (S. 1334) than it does to the earlier House Republican plan (H.RES. 232). In fact, the final compromise language is the almost the exact same plan as the Senate bill, with the same interest rate ceilings and the provision to fix interest rate for the life of the loan. The only difference in this bill is that the interest rates for the loans are .2% higher than the rates proposed by Senators Joe Manchin, Angus King, and the Senate Republicans (S. 1334). This striking similarity between the compromise language and the earlier Senate proposal is probably because the Senate proposal already had bipartisan support, while the House proposal only had House Republican support.  The .2% rate increase from the Senate bill at face value looks like a measure inserted to satisfy members of the House seeking greater revenue from student loans to potentially pay for the deficit.

With all the attention focused on interest rates, other important measures like income based repayment have slipped through the cracks. Income-based repayment (IBR) programs index annual payments to the borrower’s income. The current Pay-as-you-Earn program calculates payments to a maximum 10% of the borrower’s salary. The idea enjoys widespread support, as it was originally proposed by famed economist Milton Freidman. The logic behind the policy is simple: college graduates make more money as their career progresses. As graduates make more, they have more disposable income to pay down their debts. Unfortunately, standard loan repayment options have constant monthly payments to pay down interest and debt. This conventional strategy makes sense for auto and home loans, where people have stable, predictable income. For college graduates, having constant monthly payments eat into their more modest entry-level income.  If there is high unemployment the situation becomes even worse because students have no savings to fall back on. Under IBR, students would no longer have to pay monthly payments even if they are making little to no income. As such, tying repayments to income alleviates the threat of bankruptcy from unexpected changes in employment or income.

Even though Congress expanded the program in 2010, private loan servicers (collectors) have been hesitant in offering this as a repayment option to borrowers. In this regard, none of the above proposals do enough to expand the usage of this program. Rather, the Excel Act (H.R. 1716), a proposal that isn’t endorsed by any party, does more to make IBR the standardized repayment system. The Excel Act proposes making repaying a student loan like a withholding tax. When the student graduates, a percentage of their income paid without any extra paper work, bypassing servicers who avoid giving students these flexible terms. While the Excel Act offers no student loan forgiveness, it goes a long way to making the debt easier for students to bear. Future proposals should make IBR the standard method of repayment to reduce the number of students defaulting on their student loans.

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