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are at risk of falling into a cycle of delinquency and default unless the U.S. Department of Education changes outdated repayment and collections rules.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:
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.
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.”
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:
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.
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.