The blog of the Urban Institute
April 4, 2019

Making Student Loan Repayment More Logical and Equitable

Both Democrats and Republicans have proposed reforming the student loan repayment system to make it simpler for borrowers. Though proposals for achieving these important ends differ, they all miss a critical factor: the amount repaid should depend on the amount borrowed.

Current options and prominent proposals for federal loan repayment differ in the percentage of monthly income they require borrowers to pay and how many payments they require before balances are forgiven. But whether the payment is 10, 12.5, or 15 percent of discretionary income (the amount by which the borrower’s income exceeds 150 percent of the poverty level), the logic is similar.

Applying one rate to income above the discretionary threshold means the overall share of income paid increases with income. For example, with the current federal poverty level of $12,490 for a single person, individuals in income-based programs with incomes below $18,735 do not have to make payments on their federal student loans. Under a 10-percent system, a borrower with an annual income of $25,000 would have monthly payments of $52—2.5 percent of their income. A borrower with an income of $35,000 would pay $136 a month—just less than 5 percent of their income. And a borrower with an income of $100,000 would pay $677 a month—8 percent of their income.

Such a system works well for keeping payments affordable. But nothing in the formula relates to the amount borrowed.

Suppose our $35,000-a-year borrower’s income stays at that level. She will either stop making payments after she has paid off the amount she borrowed, with interest, or she will pay monthly for the length of time required for forgiveness—say 20 years. Over 20 years, she will make payments totaling $16,265—whether she began with $20,000 in debt, $30,000 in debt, or $50,000 in debt.

The current Revised Pay As You Earn (REPAYE) program and some proposals for reform address this problem by requiring borrowers who have any debt from graduate school to pay for a longer time before their balances are forgiven. Under the REPAYE plan, borrowers with only undergraduate debt pay for 20 years, and those with graduate debt pay for 25 years. Under the most recent proposals from the Trump administration, the requirements would be 15 years and 30 years, respectively, for these two groups. The idea is that graduate school debts tend to be larger than undergraduate debts.

A large share of borrowers with high debt levels did borrow for graduate school. The average graduate debt for those completing advanced degrees in 2015–16 (including those who borrowed only for undergraduate studies) was $50,000 (with a median of $31,000); these borrowers had taken an average of $20,100 (and a median of $17,100) in loans for undergraduate study.

But whether a borrower has graduate school debt is a poor proxy for high levels of debt. Some borrowers have small amounts of graduate debt relative to their undergraduate debt. Many students enroll in graduate school for a short time and do not complete their degrees. But even among those who completed graduate degrees with debt in 2015–16, a quarter borrowed less than $20,000 for graduate school, and half borrowed less than $40,000. Among the 2015–16 bachelor’s degree recipients who graduated with debt, a quarter borrowed $40,000 or more for their undergraduate study.

Arbitrarily raising the repayment requirements on undergraduate debt for borrowers with any amount of graduate school debt is inequitable.

Imagine two borrowers with federal debt. One borrowed $50,000 as an undergraduate, so she will repay for 15 years under Trump’s proposal (or less if her income is high enough to repay the entire debt in a shorter time period). Another borrowed $30,000 as an undergraduate and $10,000 for graduate school, for a total of $40,000. She will repay for up to 30 years. If both have the same relatively low incomes after leaving school, the graduate borrower will end up paying more for her lower level of debt.

In the table below, if the interest rate is 5 percent, the borrower with graduate debt will end up paying for more than 29 years, reaching a total of about $79,000 because her monthly payments will reduce her loan principal by only a few dollars a month after covering interest.

student loan debt

A more sensible approach would adjust the repayment period based on the total amount of federal debt a borrower has accrued.

For example, the system could require that all borrowers repay a specified share of their income every month for 15 years before the remaining balance would be forgiven. However, each $1,000 of debt beyond $31,000 (the maximum for dependent undergraduate students) would add one month to the time a borrower must repay before having balances forgiven. A borrower entering repayment owing $43,000 would repay for 16 years. A borrower entering repayment owing $151,000 would repay for 25 years. This system would still free borrowers with very low incomes from any repayment obligations, while ensuring most borrowers repay the amounts they owe through affordable monthly payments.

This system would make students think more carefully about how much debt they are taking on and would diminish the incentive for students to borrow larger amounts because they can count on the extra debt falling to taxpayers to repay. It would also diminish the incentive for graduate programs to raise their tuition prices, knowing that many students can borrow more without increasing their repayment obligations.

The goal in reforming the federal student loan repayment process should be a system that provides insurance for borrowers whose education does not pay off as well as anticipated and that is as easy as possible for borrowers to understand and navigate. The system should be fair to both borrowers and taxpayers. Students who borrow more should repay more than students with similar earnings who took on less debt. It is possible to create such a system without abandoning the goal of affordable monthly payments.

Photo by Dougal Waters via GettyImages.

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