Key Facts About Student Loan Default as Payment Pause Nears End

Editor’s note: This article was updated July 18, 2023, to reflect new information from the Biden administration on changes being made to income-driven repayment plans.

After a pause of more than three years, repayment on federal student loans will resume this fall and many borrowers are at risk of falling into a cycle of delinquency and default unless the U.S. Department of Education changes outdated repayment and collections rules.

In May, The Pew Charitable Trusts hosted a panel event with student loan researchers to discuss issues with the default system. Panelists discussed their recent work, with a focus on how default and the broader student loan repayment system can be improved to help more borrowers stay current and avoid the negative consequences associated with default. These experts focused on three key points:

Struggling borrowers experience financial strain in multiple ways  

Borrowers struggling with student loan default are likely struggling with other aspects of their financial lives as well. A Pew survey in late 2022 found that many were worried about their finances ahead of the payment restart and felt less financially secure than in the previous year. Research also shows that struggles with repayment and default are disproportionately felt by certain demographic communities. For example, a separate Pew survey indicates that 1 in 2 Black (50%) and 2 in 5 Hispanic (40%) borrowers had experienced default over a 20-year period of repayment compared with less than a third of White borrowers (29%), a finding that suggests the continued impact of longstanding economic disparities linked to structural inequities in the American economy.

“Generally we know that student loan default disproportionately affects Black borrowers … [and] borrowers … who may have debt they took out for a credential they did not complete without seeing the benefit in the labor market,” said Jason Cohn, a research analyst with the Urban Institute. He added that default also disproportionately affects older borrowers and those eligible for Pell grants, the federal grant program for students with “exceptional financial need.”

Cohn noted that historic racial disparities must be considered when discussing who defaults. For example, Black borrowers “face earnings gaps in the labor market [and] there [are] also higher levels of income volatility in Black households,” he said. “On top of that, a history of policies has prevented borrowers and Black households … from building wealth. That context is the backdrop for how student loan debt disproportionately affects borrowers by race.”

Such context shed light on why so many struggling borrowers experience multiple financial strains. Research by Pew has shown that those who have experienced default are likely to also have other consumer debts, experience employment gaps resulting in lost income, and receive public benefits.

Ilan Levine, who works on Pew’s student loan initiative, highlighted new survey findings that show labor market volatility as a major risk factor for default: 67% of borrowers who reported frequent changes in income and 60% of those who have employment gaps had experienced default.  

Sarah Sattelmeyer of the New America Higher Education Program emphasized that those in default are already financially insecure. Many may be dealing with other financial crises that can set them up for cycles of missed payments and default. Panelists said that changes are needed at the federal level to ensure a smooth transition back into repayment for struggling borrowers and to help more avoid default in the first place.

Defaulted borrowers face consequences that can trap them in default

Once a loan defaults, borrowers can face financially and emotionally exacting consequences, which can prove counterproductive to the goal of helping struggling borrowers stay on track with repayment.

Levine said borrowers were asked in the survey about the default consequences they faced. “We asked borrowers in their own words what their top reasons [for defaulting] were,” he explained. “Top reasons were higher priority debt, being overwhelmed, and having unaffordable payments.”

The consequences of default can include wage garnishment, collections fees, ineligibility for financial aid, tax refund offsets, damaged credit scores, and more.

According to the survey, nearly all borrowers who experience default face at least one consequence, with a majority experiencing two or more. These consequences can affect individual borrowers’ finances while taking an emotional toll as well. For consequences such as wage garnishment, borrowers must pay a higher share of their income than they would in the regular system under what is known as an income driven repayment (IDR) plan.

“The folks most likely to default are those who are least financially secure, which is part of the reason they defaulted, and default is exacerbating that,” Sattelmeyer noted. “It’s a downward spiral perpetuated by multiple systems, racism, [and] structural discrimination.”

Changes can help borrowers succeed

As the repayment restart approaches, the Education Department must make improvements to the repayment and default systems to set borrowers up for success instead of penalizing them for falling behind. Panelists emphasized three categories of potential actions:

• Automate repayment to prevent default. Repayment and default system automation could ease the process and help more borrowers avoid default’s consequences. Cohn stressed the importance of automation, particularly as the department works to revise the rules surrounding IDR plans to automatically place borrowers who have missed payments for 75 days into the plan with the lowest monthly payment. Effective automation requires implementation of the data sharing provisions in the Fostering Undergraduate Talent by Unlocking Resources for Education (FUTURE) Act that allow the Internal Revenue Service to automatically share income data with the department. Opting into improved data sharing would help borrowers more easily remain in an IDR plan, but it could be difficult for those disengaged with the repayment system. The department should create multiple opportunities for data sharing throughout the repayment ecosystem.
• Implement IDR improvements as soon as possible. The department recently announced the creation of the Saving on a Valuable Education (SAVE) repayment plan, which will lead to more affordable payments for low-income borrowers and protect against the unchecked balance growth that can discourage long-term engagement. Although the full plan will not be implemented until 2024, important provisions that will increase the number of borrowers making $0 payments and lessen balance growth will be available this summer. Borrowers who are enrolled in the Revised Pay As You Earn (REPAYE) plan will automatically receive these benefits and be enrolled into SAVE once it is fully available. 

As the resumption of repayments approaches, implementing the complete version of the SAVE plan as soon as possible would make it easier for borrowers to afford payments and stay out of default. Speakers at the event emphasized the findings of previous research findings that show that the early months in repayment are important for helping borrowers stay on track.

• Modernize the default system and boost Office of Federal Student Aid (FSA) funding. In addition to the reform measures described, panelists said borrowers should not pay more while in default than they would in repayment. Steps also are needed to make it easier for borrowers to transition out of default directly into an IDR plan. Yet these improvements cannot be made without appropriating adequate resources. Speakers cautioned that the Office of Federal Student Aid needs additional funding for a successful restart of payments and to implement needed reforms. “The issue with the funding of FSA is even bigger than loans. It’s ensuring that all the pieces we’ve talked about today can be taken care of,” stressed Sattelmeyer.

The discussion made clear that sweeping changes to the outdated default and collections system must be made to help borrowers stay in repayment and out of default. Current pathways out of default can be harmful or inflexible, and often do not help get distressed borrowers back in repayment. The department needs to update this system as quickly as possible after the resumption of student loan payments.

Shelbe Klebs is a senior associate and Brian Denten is an officer with The Pew Charitable Trusts’ student loan initiative.