An Income-Based Repayment System That Works for Students

May 7, 2013 Issues: Education

Published in The Hill on May 7, 2013

We are again approaching the July 1 deadline to deal with student loan interest rates.  While some argue for extending the low 3.4 percent rates, others are wary of the $6 billion annual price tag and would prefer a more long-term, fiscally-sustainable solution.  To meet this challenge, Congress should consider a bill I recently introduced—the ExCEL Act—which can bridge the divide over this issue, all while saving money and improving the system for students.

It’s disconcerting that over 13 percent of borrowers default on their federal student loans within three years of entering repayment.  While many focus on high levels of borrowing and the interest rate students pay—no doubt important issues—what is often overlooked is that a significant fraction of federal loan defaults occur on manageable amounts of debt.

The fact is our repayment system has been patched so many times over the years with well-intentioned ideas that it has become unnecessarily complex and the source of many needless defaults.  Many borrowers are not even aware of the various options available to them.

Fortunately, there is a better way.

Decades ago, conservative economist Milton Friedman and liberal economist James Tobin independently concluded that repaying student loans through fixed payments doesn't make sense.  Why?  Graduates tend to earn less when they first leave school and more over time.  Therefore, payment amounts should be an affordable percentage of a borrower's income with protections for those who struggle with low income.

Structured properly, this bipartisan idea—commonly referred to as income-based repayment (IBR)—can accomplish the goals of the array of options in our current system without the complexity that causes so many students to fall through the cracks.  We do have an IBR option now, but unfortunately, it does not live up to its potential.

Currently, IBR is not standard and is administratively difficult for students to manage.  Payments are based on the borrower’s previous year’s tax return, and when income changes throughout the year—including unemployment—it is the obligation of the borrower to file the necessary paperwork to change the payment amount.

Building on successful reforms in the United Kingdom, Australia, and New Zealand, my bill makes IBR the universal repayment method for federal student loans and streamlines it by allowing borrowers to repay through the employer-withholding system.  This makes payment amounts automatically responsive to changes in income without the paperwork burden.

These reforms make sense and they’re proven to work: In the U.K., for instance, 98 percent of borrowers are meeting their obligations.

We must also have a system that’s fiscally sustainable, and right now that’s not the case.  Currently, IBR offers borrowers forgiveness after 20 years.  As researchers at the New America Foundation have shown, this can be a windfall for many students, particularly high-debt graduate students who borrowed without limit under the federal loan program.  We cannot have a system where taxpayers absorb ever-higher levels of unpaid debt. 

Under the ExCEL Act, low-income graduates would have strong protections against unchecked interest growth—such as a cap on the total amount of interest any borrower can accrue on a loan—but all borrowers would have a responsibility to repay what they borrow.  For similar reasons, my bill would discontinue the Public Service Loan Forgiveness program, which provides unlimited forgiveness to anyone who works for ten years in the public sector—a benefit which is neither fair nor fiscally sustainable.

These reforms go hand-in-hand with our interest rate dilemma.  I propose tying student loan interest rates to market rates, similar to the proposals put forth by Senators Coburn, Burr, and Alexander, the Obama administration, CBO, and the New America Foundation.  Skeptics argue that we should continue the current subsidized interest rate or cap how high market rates can rise.  In response, the Obama administration and others have rightly argued that IBR ensures that struggling borrowers would never face unmanageable levels of debt in repayment.  Therefore, protections are targeted more directly to those who most need them.

My bill discontinues the in-school interest subsidy for the same reason, freeing up taxpayer dollars for other priorities such as Pell Grants, which have more evidence of success than interest subsidies, or deficit reduction.

The concept of income-based repayment has had wide-ranging support and has been advocated by presidents from Reagan to Clinton to Obama.  The reforms in the ExCEL Act are right for students and taxpayers and can end the perennial debate over interest rate subsidies once and for all.