Upcoming Rule-Making Process Should Redesign Student Loan Repayment

Student loan income-driven repayment (IDR) plans—which calculate monthly payments based on income and family size—help to reduce the risk of delinquency and default for many borrowers. Federal Student Aid reports that about 30% of borrowers are enrolled in such plans, a finding mirrored in a recent Pew survey. However, current and former borrowers who have used IDR plans report problems with their plan’s design, including unaffordable payments, balance growth, and confusing enrollment procedures.

The Department of Education this spring established a rule-making committee to consider reform of regulations related to income-driven repayment, among other important higher education issues. As the committee starts its meetings in October, members should focus on redesigning IDR plans to make them more affordable for low-income borrowers, limit the balance growth that can impede repayment, and ensure that borrowers can enroll easily.

A spring 2021 Pew survey of 2,806 people, including over 1,000 borrowers, gives a sense of their concerns. For example, 61% of those in IDR plans said the need for a lower payment was the most important reason they chose to enroll. Even after doing so, nearly half (47%) of those previously or currently in such a plan reported that their monthly payments were still too high. This could be caused by incomes that vary from month to month or by high expenses, such as those for child care or health care.

The committee can also address the reality that many borrowers in IDR plans experience high balance growth, which can cause discouragement and frustration. In the Pew survey, 72% of those who had ever been enrolled such a plan and who had started repayment said they owed more or approximately the same at that point as what they originally borrowed, compared with 43% of borrowers who had never been enrolled in an IDR plan.   

IDR plans are intended to lower monthly payments but doing that can extend repayment periods and increase balances, especially if borrowers’ payments do not keep pace with the amount of interest that accrues each month. Pew focus groups have shown that this may result in negative psychological effects. As they start to pay down the loan balance, borrowers see little progress, which can cause frustration or sap the motivation to repay.

Complex enrollment requirements also present a barrier for those seeking more affordable payments. Pew’s survey found that 44% of respondents who had ever enrolled in an IDR plan said that the application process was somewhat or very difficult to navigate. These struggles may be related to enrollment obstacles such as limited information and assistance from loan servicers or problems with the required annual recertification of income and family size.

Many borrowers also report not knowing that IDR plans exist. Among respondents who had never enrolled, 48% said not being aware of the program was the primary reason. That group may include many low-income borrowers, who research shows are less likely to enroll than borrowers with moderate incomes. These findings suggest that the department and servicers should expand outreach efforts and increase the quality of information about the benefits of income-driven plans to borrowers most in need of help affording payments.

Focus on affordable payments

As the rule-making starts, negotiating committee members should focus on how to make payments more affordable for low-income borrowers, reduce balance growth, and boost enrollment among struggling borrowers. Because policymakers have a range of options, additional modeling and data can help identify which reforms would best target the needs of low-income borrowers, the people at greatest risk of encountering repayment challenges. Upcoming research by Pew will identify the advantages and drawbacks of different approaches.

Among the possibilities, updated or new IDR plans could lower the percent of a borrower’s discretionary income used to calculate payments, which would result in a lower repayment burden. Negotiators could also increase the amount of income excluded from the calculation for monthly income-driven payments.

Existing IDR plans generally exempt 150% of the federal poverty guideline, depending on family size and state, from the payment calculation. Increasing the amount protected could help ensure that more low-income borrowers can afford payments. Considering borrowers’ expenses in the calculations—including those related to child care or health care—also could help ensure that they are not financially strained by their monthly student loan payment, though this change could add substantial complexity to the program.

Target balance growth

To help reduce balance growth, negotiators could consider eliminating or limiting interest capitalization in IDR plans to prevent balances from ballooning. Currently, unpaid interest is capitalized—added to the principal—in certain situations, increasing the amount subject to future interest charges. This can happen when borrowers change plans or if their annual income recertification is not submitted or processed on time. The department has said that interest capitalization serves no financial purpose other than to generate additional interest income for the government, except in the case of loan consolidation.

Negotiators could move to cap the amount of unpaid interest that can accrue each month in IDR plans, waive interest for low-income borrowers, or pause interest accrual during periods of deferment or forbearance when borrowers are enrolled in such plans.

Make the process easier to navigate

Changes to the regulations also could help boost enrollment in IDR plans among those borrowers most likely to encounter repayment challenges. For example, streamlining the number of existing plans would reduce borrower confusion and make the program easier to access and implement. Although the committee may have limited ability to consolidate congressionally authorized plans, members should look to reduce the number of plans as much as possible within this process.

Research also supports allowing borrowers who have defaulted to enroll in income-driven plans, rather than requiring them to first navigate the lengthy and complex loan rehabilitation process. Enrollment in an IDR plan substantially decreases the likelihood that borrowers who have defaulted will do so again. Still, the Consumer Financial Protection Bureau found in 2017 that fewer than 1 in 10 borrowers who completed rehabilitation were enrolled in such plans within nine months of exiting default.

Now is the time to craft regulations for income-driven plans that work for borrowers, especially those most at risk of delinquency and default and who would most benefit from lowered monthly payments. As they work toward making changes in this fall’s sessions, negotiators should carefully consider the potential benefits and shortcomings of various options to provide relief to low-income borrowers as they create a more affordable and accessible approach.

The student loan survey was conducted for The Pew Charitable Trusts by SSRS through the online SSRS Opinion Panel. Interviews were conducted May 10, 2021, through June 16, 2021, among a representative sample of 2,806 total respondents. The margin of error with design effect for all respondents is plus or minus 3 percentage points at the 95% confidence level.

Travis Plunkett is the senior director of the family economic stability portfolio, Regan Fitzgerald is a manager, and Brian Denten and Lexi West are senior associates with The Pew Charitable Trusts’ project on student borrower success.