Federal loans provide students with the cash they need to meet expenses while in college, allowing them to repay their debts out of their postcollege earnings. Income-driven repayment (IDR) plans provide insurance, protecting borrowers in the event their investment in education does not generate the financial return required to pay off these debts without undue hardship.

But as currently structured, IDR has some serious shortcomings. Borrowers with small balances and very low incomes may be in repayment for 20 years, watching their balances grow because their incomes are too low to allow them to cover even the interest payments. Forgiving these debts more quickly would eliminate some of the most senseless cases of student debt creating long-term hardship.

Another shortcoming of IDR is that because payments depend only on income and not on debt levels, many borrowers with similar income paths make the same payments over the life of their loans, regardless of how much they borrowed. If Alison borrows $30,000 and Elaine borrows $50,000 and neither earns enough to fully retire their debts over 20 years, with similar incomes they will make similar payments before having remaining balances forgiven. Alison essentially turned down a $20,000 gift when she decided to moderate her borrowing.

It is possible to address these problems by making time in repayment sensitive to amount borrowed. Such an approach could apply to any level of undergraduate borrowing currently permitted under the federal student loan system, though it would require a cap on the total level of debt eligible for forgiveness in the system, diminishing the large share of subsidies now going to those who borrowed for graduate school (PDF).

Linking time to repayment to amount borrowed

Under the current IDR system, a borrower who owes just $6,000 will be in repayment for 20 years unless his starting income is at least $20,000, assuming annual income growth of 4 percent. With a starting income of $15,000, he will not make payments until the 15th year, when he will owe $48. After 20 years and total payments of $1,148 ($687 discounted to current value), the government will forgive the $9,652 in principal and accumulated interest he owes.

An alternative system could begin with a short repayment period for small debts and add months incrementally as the amount borrowed increases. As a starting point for developing such a system, I begin from the level of debt of the average bachelor’s degree recipient, who has borrowed about $30,000. I propose decreasing the amount of time this typical borrower has to repay from 20 to 15 years and adding one month of payments for each additional $200 of debt, or subtracting one month for each $200 decline in the beginning balance. (The monthly IDR payments for borrowers with incomes typical of recent bachelor’s degree recipients are about $200.)

As the graph below indicates, the hypothetical borrower with $6,000 in debt would be in repayment for only five years. If this borrower earned at least about $28,000, they would repay the full amount within this short time period.

The impact of the reformed system

A system that forgives the debt of those who borrow small amounts more quickly (probably along with immediate forgiveness for those with these debt levels who have already been in repayment for the newly required amount of time) would free borrowers with small debts from many years of zero or small payments.

The proposed repayment plan would significantly diminish the burden on borrowers with small amounts of debt without costing the government much. Low-income borrowers have no payment requirements, frequently for many years. Some receive debt forgiveness exceeding the amount they borrowed after 20 years because of accumulated interest. Borrowers with higher incomes pay off small debts quickly. A borrower entering repayment with $10,000 in debt and a starting income of $30,000 requires just 8 years of IDR payments to pay off the full amount.

This plan also means borrowers with similar incomes but different debt balances would be more likely to pay different amounts. For those with more than $42,000 in debt, repayment could last longer than the current 20 years. Currently, one-quarter of borrowers hold this much debt. Many of them went to graduate school and are already in a 25-year repayment plan.

As the table below illustrates, borrowers owing $6,000 would pay for no more than 5 years under the proposed plan. Borrowers owing $30,000 would pay for no more than 15 years. A starting income of $40,000 would lead to full repayment after 14 years, as in the current system. But those with lower incomes would have remaining balances forgiven after 15 years.

Borrowers owing $54,000, close to the maximum amount of federal debt for independent undergraduate students, would be in repayment for up to 25 years. Those with starting incomes exceeding $40,000 would repay their entire debts.

Years until Debt Is Either Paid off or Forgiven

Note: Assumes 4 percent interest, 2 percent annual increase in threshold for making payments, and 4 percent annual income growth.

Because borrowers with different levels of debts would be in repayment for different lengths of time, the new system would eliminate the problem of dollars repaid being independent of amount borrowed. That is, most borrowers who borrowed less would also repay less.

IDR repayment provides vital protection to students who borrow in the face of uncertainty about the payoff their education will generate. But the current system has flaws that make it inequitable and inadequate to the task of preventing debt from plaguing borrowers who left school without valuable credentials. Reforming the system to make time in repayment a function of debt levels—either with the pattern illustrated here or a similar one—would require addressing unusual circumstances and predicting possible responses but would go a long way toward creating a more functional system.