President Biden’s Student Loan Forgiveness Announcement: “Fixing” Income-Driven Repayment Plans

By: Sarah Holden

Disclaimer: The views expressed in this post are those of the author, and do not necessarily reflect views of the Journal, the William H. Bowen School of Law, or UA Little Rock.

I. The Proposed Changes
On August 24, 2022, President Biden’s Administration announced that it was going to provide up to $20,000 in federal student loan forgiveness for low- and middle-income families. Details about the procedural mechanics of the forgiveness are still forthcoming, but eligible borrowers—individuals with income under $125,000 or married couples with income under $250,000—could expect to see $10,000 in federal student loan debt forgiven, with up to an additional $10,000 in forgiveness available to Pell Grant recipients. This debt cancellation plan would cover the full balance of approximately 20 million borrowers and bring relief to as many as 43 million people. While it remains to be seen how the Administration will tackle potential legal hurdles related to the debt cancellation, the announcement also includes a proposal that is garnering significantly less public attention and yet stands to have a more long-term impact to many borrowers: “fixing” the overly complicated income-driven repayment plans that are currently riddled with expensive risks.

What exists today is a minefield of confusing limitations, loan requirements, eligibility criteria, and repayment terms that obfuscate both the benefits and the risks of participating in these plans. The announcement proposes several changes to income-driven repayment plans, including lowering the discretionary income threshold to 5% for undergraduate loans and raising the amount of income considered non-discretionary, both of which could help address concerns that monthly payments are still unaffordable for many borrowers. Also discussed is forgiving small balances (less than $12,000 originally borrowed) after ten years in an income-driven repayment plan rather than twenty. The change that could be the most impactful long-term, however, relates to accruing interest: “no borrower’s loan balance will grow as long as they make their monthly payments—even when that monthly payment is $0 because their income is low.” Changing the treatment of accruing interest would benefit borrowers across all income levels by providing relief based on debt-to-income ratio as opposed to a flat income threshold.

II. The Current Landscape of Income-Driven Repayment Plans 
Student loan repayment plans that calculate a borrower’s monthly payment as a function of the borrower’s income (e.g., “income-driven” repayment plans) are a key benefit of modern federal student loans. While income-driven repayment plans are intended to make repayment more manageable, and thereby reduce the default risk, utilization of these plans has remained low; as of 2017, less than half of eligible borrowers were enrolled in an income-driven repayment plan. One of the key reasons for this low utilization rate is obvious to anyone who has visited and tried to figure out for themselves which repayment plan, if any, they should enroll in. Information about the different plan designs, income certification requirements, borrower or loan eligibility, repayment terms, consequences of leaving a plan, and more—all of this information is provided, but it is easy to get confused or feel overwhelmed. This is especially true considering the large variety of student loan repayment plans that exist today (as many as fifty different plans have been authorized by Congress, though not all are currently in operation).

When the Higher Education Act passed in 1965 and created the Guaranteed Student Loan Program, student loans were to be repaid under a Standard Repayment Plan which required repayment within ten years. By the 1990s, as the cost of attending college was sharply increasing, the first income-driven repayment option became available—the Income-Contingent Repayment Plan. Two additional plans were also introduced: a repayment plan that gave the borrower additional time to repay (the Extended Repayment Plan) and a plan that kept the standard ten-year term but structured the payments to increase every two years, attempting to more closely match a borrower’s income growth after graduating college (the Graduated Repayment Plan).

Not all repayment plans cancel a borrower’s remaining balance after a certain number of years (e.g., the Standard, Extended, and Graduated Repayment Plans offer no “forgiveness” feature), but, of those that do, among the most ubiquitous include:

  • Pay As You Earn (PAYE) – monthly payments are fixed at 10% of a borrower’s discretionary income for a twenty-year term, not to exceed the payment amount that would have been owed under the Standard Repayment Plan, and any remaining balance would be forgiven once the repayment term ends;
  • Revised Pay As You Earn Repayment Plan (REPAYE) – monthly payments are fixed at 10% of discretionary income for twenty years, similar to PAYE, but spousal income is automatically factored in when determining monthly payment amounts; REPAYE is only available during periods in which a borrower may qualify to make income-based payments (i.e., if a borrower’s Standard Repayment amount would be less than 10% of discretionary income, a borrower becomes ineligible for REPAYE);
  • Income-Based Repayment Plan (IBR) – monthly payments are fixed at 10–15% of discretionary income for twenty or twenty-five years; IBR is available only during periods in which a borrower qualifies to make income-based payments as determined by the borrower’s debt-to-income ratio;
  • Income-Contingent Repayment Plan (ICR) – monthly payments are the lesser of either (1) 20% of a borrower’s discretionary income or (2) the amount owed under a fixed twelve-year term.

While each of the above plans may appear relatively similar, there are important differences that quickly become confusing to navigate. For example, the amount of a borrower’s monthly payment could vary based on which plan the borrower was enrolled in, yet not all plans are available for all borrowers. Borrowers with loans issued under the Federal Family Education Loan (FFEL) program are only eligible to participate in the IBR plan, yet a borrower may lose that eligibility as their income increases. Consolidating the FFEL loan(s) into a Direct Consolidation Loan could enable those with FFEL loans to have access to the REPAYE, PAYE, and ICR plans, but consolidation comes with its own risks, such as increased interest rates or causing a borrower to restart progress towards other forgiveness plans (such as Public Service Loan Forgiveness (PSLF)). Moreover, some plans (or some plan features within a single plan) are only available to “new” borrowers. For the IBR plan, all borrowers are eligible to participate (provided they meet the requisite debt-to-income ratio), but only “new” borrowers receive the twenty-year repayment term; all others are given the twenty-five year term. In contrast, only new borrowers are eligible to participate in the PAYE plan. However, the criteria for being considered a “new” borrower is completely different for the PAYE and IBR plans.

III. The Potential Costs of Participating in Income-Driven Repayment Plans
The unbelievable complexity of these plans results in countless hoops a borrower must jump through in order to actually see a long-term financial benefit from having participated. While a lower monthly payment is frequently a lifeline to borrowers struggling financially, lowering a borrower’s monthly payment invariably increases the amount of time a borrower remains in debt and frequently causes the borrower to pay more in interest over the life of the loan. For example, a borrower with $30,000 in student loans may have an interest rate of 6.8%: when the loan is repaid in ten years, the borrower will pay $11,429 in interest, but when the loan is repaid in twenty years, the cost of interest more than doubles to $24,960. From 2013 to 2020, direct loan balances in repayment increased approximately 180%, but direct loan balances in income-driven repayment plans increased over 600%.

In the event a borrower is able to achieve more financial stability and no longer needs the lower payment, a borrower may find that their principal loan balance has actually grown (i.e., the loan has negatively amortized). Negative amortization occurs when (1) a borrower’s monthly payment is reduced to the point that the borrower is not paying off the interest that is accruing on the loan each month and (2) an event occurs that triggers the unpaid interest to be capitalized (added to the principal loan balance). Unsurprisingly, the point at which capitalization may occur varies by plan. Nevertheless, capitalization of interest puts all borrowers who participate in income-driven plans at risk of increasing their overall loan balance simply by participating in the “benefits” of the plan. An increase in a borrower’s principal balance leads to a correlating increase in the cost of interest, causing a borrower’s enrollment in an income-driven repayment plan to lead to the perverse result of creating student loan debt that is even more difficult to repay.

Under PAYE, REPAYE, or IBR, a borrower could have unpaid, accrued interest capitalized merely by failing to re-certify their income by the deadline. The timely recertification requirement must be met every single year for twenty to twenty-five years (depending on the repayment plan). A family of four with an annual household income of just $45,000, paying on $30,000 in student loans at an interest rate of 6.8%, could have as much as $1,200 in unpaid interest accrue each year while participating in the PAYE or REPAYE plans. This occurs because the monthly payments under either plan would set the borrower’s monthly payment to just $68, failing to cover even half of the $170 per month cost of interest, let alone covering any principal. If the borrower failed to re-certify after being in either plan for just five years, as much as $6,120 could be capitalized, increasing the principal balance to $36,120. The impacts of capitalizing interest are compounding—although the borrower could re-certify late in order to continue making the lower, income-driven payments, the increased balance could make it difficult for the borrower to qualify for favorable rates on other loans, increasing the cost of incurring any other kind of debt, or it could prevent the borrower from qualifying for another loan entirely.

Although average income grows as a person’s level of education increases, so does the average amount of student loan debt. While clearly an individual making a salary of $60,000 may be more capable of making payments on their student loan debt than a family of four making $45,000, a first year medical resident can only expect to make around $60,000 while shouldering an average student loan debt burden of $241,600. An unmarried medical resident with $241,600 in student loan debt, at an interest rate of 6.8%, might expect to pay roughly $350 on her student loans each month by participating in either the PAYE or REPAYE plans. This may seem completely innocuous at first. However, if, upon finishing a three-year residency program, she forgets to re-certify her income before the deadline, or if her income spikes and she becomes ineligible to participate in the plan, she could experience capitalization of approximately $45,000 (three years of unpaid accrued interest). This would bring her total outstanding loan balance to over $286,000 and results in almost $94,000 of additional costs over the life of the loan. Put another way, the capitalization of this unpaid interest effectively adds six additional years of student loan payments to what was already a twenty-five year term.

IV. Achieving Long-Term Reduction in Student Debt
The changes to income-driven repayment plans mentioned in the August 24 announcement are merely proposals, so it remains to be seen what, if any, changes are actually implemented. It is possible that a single, simplified plan could benefit everyone, though it would be reckless to suggest that existing plans should be made completely unavailable without knowing more about who might continue to benefit from these older plans. It is abundantly clear, however, that the vast majority of borrowers would benefit from less complexity. Moreover, information about the available plans should be completely overhauled so that it is less overwhelming to navigate through each plans’ features. At an absolute minimum, all plans should remove the risk of capitalizing interest; participation in an income-driven repayment plan should never cause a borrower’s balance to increase while the borrower is making the required monthly payments, regardless of the borrower’s income level. Failing to re-certify income should not bear such long-term, drastically expensive consequences. Moreover, borrowers who are able to increase their income, or decrease their student loan debt, to the point that they no longer need the benefits of one of these plans, should not be penalized by having unpaid accrued interest added back to their loans.

While forgiveness of up to $20,000 in federal student loans would unquestionably reduce the massive amount of student loan debt in the United States (currently reported to be as much as $1.748 trillion), that reduction will only be temporary without permanent changes that make it easier for borrowers to get out of debt. Ideally, existing income-driven repayment plans should be overhauled and simplified, as opposed to the Biden Administration just adding yet another option and even more confusion. At an absolute minimum, it should be abundantly clear that the compounding problem of capitalizing interest must be removed from these and future plans if a long-term, sustainable reduction in student loan debt is to be achieved.


About the author:

Sarah is currently a 2L student at the University of Arkansas at Little Rock, William H. Bowen School of Law.

Posted in: Blog Posts, Legal Comentary

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