Today, the US Supreme Court ruled against the Biden administration’s student loan forgiveness plan, meaning borrowers will not receive broad-based debt cancellation. As student loan payments are now set to restart in September, reforms are needed to ensure the loan system can work better for borrowers most vulnerable to default.
Evidence suggests fewer than half of student loan borrowers feel financially secure, and more than three-quarters have had a recent adverse financial event, such as being unable to make a full payment on their mortgage, rent, or another bill. This financial insecurity indicates the transition back to repayment at the end of the student loan pause could be difficult for many.
Who’s at risk of default?
The Biden administration’s loan forgiveness plan would have reduced most borrowers’ balances by $10,000, with an additional $10,000 reduction for those who received a Pell grant because they were from households with low or moderate incomes. As a result, up to 45 percent of borrowers, including more than 50 percent of Pell recipients, would have had their student loan debt completely wiped out. This group includes many borrowers who’ll now be vulnerable to default as payments restart.
Research shows borrowers most likely to default are those who have defaulted at least once before and those who did not complete a credential. Because of labor market discrimination and racial wealth gaps, among other structural barriers, Black and Latine borrowers are also more likely to default. And those who default typically have balances below $20,000—amounts that would have led to full forgiveness under the administration’s plan—meaning a restart of payments without loan forgiveness leaves a disproportionate share of vulnerable borrowers with debt.
Among borrowers who started school in the 2011–12 academic year and received Pell grants, 21 percent defaulted within the following six years. Of those defaulters, 91 percent had borrowed less than $20,000. Although this is just one cohort of borrowers and we can only look at the amount borrowed rather than current balance, this measure indicates that $20,000 of forgiveness would have kept many Pell grant recipients out of default.
How to support borrowers at risk of default
As payments resume, borrowers currently in default can opt for Fresh Start, a program which returns their loan to a current repayment status and removes the default from their credit record. But these borrowers, along with those who haven’t defaulted but may be at risk of default, may need additional supports to stay in active repayment and, if they do default, make it easier to cure their default without major financial loss. To help support these borrowers, policymakers could do the following:
- Prioritize implementation of automatic enrollment in income-driven repayment (IDR). Borrowers currently have to opt into an IDR plan, but many are unaware they exist. Proposed changes to IDR would automatically enroll a borrower if they are 75 days delinquent and have given the Internal Revenue Service permission to share their income data. This new feature could prevent most defaults, but without adequate funding to the Office of Federal Student Aid, implementation may be slow. Further, it’s unclear how current borrowers will consent to data sharing. The Department of Education has many competing goals this year, but prioritizing implementation of automatic enrollment and making it simple and clear for borrowers to give data sharing permission could ease the transition back to repayment for borrowers most at risk of default.
- Expand eligibility for loan rehabilitation. Loan rehabilitation allows borrowers to exit default by making nine voluntary payments and removes the default from the borrower’s credit record. But borrowers are only allowed to rehabilitate a loan once, even with redefault common after loan rehabilitation. The Fresh Start program temporarily allows borrowers to rehabilitate a loan a second time if they did so during the payment pause, but many borrowers had already used the option before the payment pause and are ineligible as a result. Congress could allow all borrowers a second opportunity regardless of whether they’ve been through the process before, which could help many borrowers build up their credit more quickly after exiting default.
- Align rehabilitation payments and debt collections amounts with IDR payments. The monthly payments required for a borrower to rehabilitate their loan are based on their income. Specifically, the payments are equal to 15 percent of income above 150 percent of the federal poverty level. Similarly, defaulted borrowers are subject to wage garnishment and can see as much as 15 percent of their discretionary income withheld at the request of their loan servicer. These amount to larger payments than the borrower would be making under an IDR plan. The current, most generous IDR plan requires borrowers to pay 10 percent of their income above 150 percent of the federal poverty level, and proposed changes to IDR would result in monthly payments equal to 5 percent of income above 225 percent of the federal poverty level. As the Department of Education plans to improve debt collections practices, it could align rehabilitation payments and debt collections amounts with IDR to create a less punitive default system, minimize the financial strain on borrowers already experiencing financial hardship, and create a smoother transition for borrowers to finish repaying in IDR after exiting default.
Borrowers who default on their loans experience a range of consequences, including wage garnishment, tax refund offsets, harm to their credit scores, and collection fees. These borrowers are typically already struggling in other aspects of their financial lives before defaulting. By designing the loan system to prevent more defaults and make the consequences of default less severe, policymakers can help protect borrowers from experiencing unnecessary burdens that hinder their financial recovery.