Whether to extend the six-month pause on federal student loan payments has become one of many sticking points in stimulus negotiations, with Senate Republicans proposing to let the pause end on September 30 and simplify and expand income-driven repayment and Democrats lobbying to extend and possibly expand the pause.
The Coronavirus Aid, Relief, and Economic Security Act reduced interest rates on federal student loans to 0 percent and eliminated required payments from March 13 to September 30, 2020. Congress also directed the federal government to stop collecting payment through processes like wage garnishment, social security payments, and earned income tax credits. The legislation also promised that for borrowers working toward forgiveness, the months of $0 payments would count toward the amount of time they were expected to repay their loans.
In the face of an immediate health and financial crisis, this one-size-fits-all approach provided a streamlined way to offer relief to student loan borrowers who had lost income, even if the policy disproportionately benefited higher-income households. But as the crisis becomes status quo, some policymakers are looking for solutions that provide relief to households in need without providing taxpayer-funded subsidies to others.
Why the student loan system fails too many borrowers during a crisis
Before the pandemic, about one-third of borrowers whose student loans had come due (and about half the outstanding debt) were in income-driven repayment (IDR) plans, which limit monthly payments to a percentage of current income (typically 10 percent of income above 150 percent of the federal poverty level). Those with incomes below the threshold don’t have to make payments, and any unpaid balance is forgiven after 20–25 years.
In theory, IDR allows borrowers to make smaller or no payments on their student loans when their incomes decrease, including during a health crisis. But in practice, it often doesn’t work this way. Some borrowers never manage to choose among and access the complicated set of IDR plans, and those who do must submit new paperwork every time their income changes (and at least every year) to get the promised benefits.
And during the pandemic, these bureaucratic barriers become particularly problematic because of the large number of borrowers whose incomes have changed.
Black borrowers and those with low incomes are particularly vulnerable. Black students borrow more on average than others pursuing the same education and have lower incomes than others with similar credentials because of the racial wealth gap and employment discrimination, among other factors. Black adults are also among the populations most likely to have lost their jobs because of the pandemic.
The process of documenting income changes and the lag in seeing changes to required student loan payments, compounded with the pandemic’s disproportionate effects on the Black community and on people with low incomes, threaten to exacerbate both racial and income inequality.
How the pause affects different kinds of borrowers
The current payment pause works well as a quick fix for struggling borrowers but is a blunt instrument given the wide range of circumstances facing borrowers. To understand the trade-offs, consider two hypothetical borrowers.
The first borrower has $10,000 in loans he took out before dropping out of a for-profit college for a credential as a hairdresser. Because of the pandemic, his current annual income is $10,000.
The second borrower borrowed $200,000 to obtain a law degree. She has a job in the federal government with a starting salary of $80,000.
Before the student loan pause, both borrowers would have been best off using an income-driven repayment plan. The low-income hairdresser would make no payments and have all of his loans forgiven after 20 years. The government lawyer’s payments would start at about $500 per month. After 10 years of payments, her remaining balance—probably more than $200,000 including interest—would be forgiven.
The higher-income borrower will get a much larger benefit from the pause than the lower-income borrower. The benefits of the pause on interest charges are even larger for those with higher incomes and large debts.
Options for congressional action
As these examples show, the challenge facing Congress is quickly legislating a short-term solution that effectively protects borrowers affected by the crisis without directing large benefits to borrowers who are able to continue paying their loans under existing policy. Options include the following:
Rethinking IDR: Senator Lamar Alexander (R-TN) recently proposed (PDF) consolidating all of the income-driven plans into a single income-driven choice. Advocates have long called for this simplification, but many question its efficacy as crisis response, as it would be virtually impossible to solve the enrollment and income verification issues immediately.
IDR would be the most effective solution, especially in a crisis, if all borrowers were enrolled and their payments adjusted automatically as their incomes change. If, as in some other countries, employers deducted borrowers’ payments from their paychecks along with their income taxes, payment reductions would be automatic. But quickly establishing a nationwide system of student loan collection through payroll withholding in the middle of a national crisis would likely be impossible.
Extending the pause: Congress could extend the current pause for another six months. If that occurs, Congress might also seek a strategy for including federal loan borrowers left out of the current provision.
Extending the pause with different conditions: The payment pause could be extended without the 0 percent interest and forgiveness provisions of the current pause. Or, these benefits could be limited to borrowers with the lowest incomes. This solution would be more targeted but would require action by borrowers and servicers (for example, to document income), which would make it harder to reach everyone needing help. Lawmakers could also try to streamline eligibility requirements, such as by including borrowers who participate in means-tested programs, such as the Supplemental Nutrition Assistance Program, or who have successfully filed for unemployment insurance.
Protections for missed payments: Congress could automatically provide forbearance to borrowers who miss payments so they don’t end up delinquent, which would provide a minimal level of protection, and automatically rehabilitate all defaulted loans when the crisis ends. But this would only postpone difficulties for borrowers suffering severe financial damage from the pandemic, unless Congress establishes longer-term solutions, such as automatic IDR.
Effectively extending protections for borrowers who need it is critical, but policymakers seeking to provide help where it is needed most should, to the extent possible, focus assistance on those whose circumstances have been particularly affected by the pandemic, buying time to implement a permanent solution.