How Student Loan Forgiveness Will Transform College Funding
The income-based repayment (IDR) program proposed in Biden’s student debt relief plan “could dramatically change the way people fund college,” according to Kent Smetters, director of the budget model faculty. from Penn Wharton, a nonpartisan research initiative that analyzes the fiscal impact of public policy. “It could almost make college free, or nearly free, for a lot of people. Many more people could go to college. Smetters, who is also a professor of business economics and public policy at Wharton, made the observations while discussing PWBM’s study of the debt relief plan recently on the Wharton Business radio show. Daily on SiriusXM.
Details of the new plan
Income-based reimbursement plans have been around for a long time in the US Department of Education, but the new plan will be “much more generous than existing programs,” Smetters noted. The new rule would require borrowers to pay no more than 5% of their discretionary income per month on undergraduate loans, compared to 10% available under the most recent income-driven repayment plan.
It would also increase the amount of income considered non-discretionary income and therefore protected against reimbursement. It aims to ensure that no borrower earning less than 225% of the federal poverty level — about the annual equivalent of a $15 minimum wage for a single borrower — will have to make a monthly payment, according to a memo. the White House on the map. Additionally, it would cover the borrower’s unpaid monthly interest so that no borrower’s loan balance will increase as long as they make their monthly payments – even when that monthly payment is zero because their income is low.
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Federal student loan repayments have been suspended since March 2020 as part of COVID-19 relief measures, and the new plan extends that pause “one last time” through December 31, 2022, with payments resuming in January. 2023. To ease this transition to repayment, the new plan will offer debt forgiveness of up to $20,000 to Pell Grant recipients and up to $10,000 to non-Pell Grant recipients, as long as their income is less than $125,000 (for individuals) or $250,000 (for households). Another feature of the new plan is to write off loan balances after 10 years of payments, instead of 20 years, for borrowers with loan balances of $12,000 or less.
Invitation to Max Out Loans?
Smetters highlighted the generous dimensions of the new income-based repayment plan: capping monthly payments at 5% of discretionary income; redefining discretionary income to make it much smaller than it was under current law; and the government will “essentially make payments on your behalf so that your loan balances never increase, even if you make payments below the interest rate.”
Under existing programs, a student borrower’s debt would increase if he did not repay the interest in full; he would be pardoned later after reaching the deadline — usually 20 years, Smetters continued. “The idea was simple: suppose your income increases much later, then you would be expected to pay off that debt. One of the reasons for the low number of signups could be because of this feature – i.e. you are racking up a lot of debt at a higher interest rate than you would eventually have to pay off.
Under the new IDR program, this effect would disappear, Smetters pointed out. “So even if you thought your income might increase, you would still want to enjoy the new IDR in the meantime. That’s the reason why there is hardly any downside to signing up.
“I’ve had people tell me before that why even put a 529 plan in place,” Smetters noted. (A 529 plan is a tax-advantaged plan to encourage savings for higher education). “Many students have even mentioned to me [that they] should take on as much debt as possible, as payments are going to be severely capped under the new income-tested repayment scheme.
“If people are really rational and if they really believe this program will last, it should fundamentally transform the way education funding is done because many students would have an incentive to maximize loans to pay for their education,” said Smetters. . “Why do this summer job? Why do your parents or grandparents contribute?
Costs could exceed $1 trillion
Smetters said he didn’t expect the White House to release data on the costs of such a generous program. But the analysis that PWBM economist Junlei Chen produced under Smetters’ direction estimated the program’s costs over its 10-year budget window: Canceling student debt will cost between $469 billion and $519 billion. dollars, depending on whether existing and new students are included. ; about 75% of this benefit will go to households earning $88,000 or less per year. Loan forbearance for 2022 will cost an additional $16 billion.
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Under strict “static” assumptions about student borrowing behavior and the use of participation rates in existing income-based repayment programs, the proposed new IDR program will cost an additional $70 billion, increasing total costs of the package to $605 billion, according to the study. But depending on how the IDR program plays out and changes in student borrowing behavior, it could add an additional $450 billion or more, bringing the total costs of the plan to over $1 trillion. added the study.
Features of the new IDR proposal could significantly increase take-up rates, the PWBM study notes. Current PWBM calculations don’t even take this effect into account yet, Smetters said. “They only represent the higher participation rates in the income-based program, assuming existing funding is student-driven. Our cost numbers will become important once we factor in the shift to more borrowing.
A majority of qualified borrowers do not enroll in existing programs, according to a previous PWBM brief. PWBM plans to study the distributional effects of the new IDR program and related aspects in future reports.
The federal student loan portfolio currently totals more than $1.6 trillion, owed by about 43 million borrowers, according to a Forbes report. Federal student loans make up the vast majority of US student debt – approximately 92% of all outstanding student loans are federal debt. About 5% of student debt was at least 90 days past due or in default as of the fourth quarter of 2021, the report adds. That number is artificially low because federal student loans are currently on forbearance, he pointed out.
(Knowledge at Wharton published this article for the first time.)
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