By Mark Huelsman | September 16, 2021
More than 45 million Americans now owe on federal student loans, taken on in service of their educational dreams. For too many, this debt has negatively affected nearly every piece of their financial lives, including the decision to own a home, save for retirement, start a small business, get married, or simply their ability to manage their everyday spending. Student debt also contributes to our nation’s persistent and unconscionable racial wealth divide: by and large, Black and Latino borrowers are forced into more debt and face more of an uphill battle in repayment due to persistent and structural injustice in the labor market and beyond.
Nearly three decades ago, Congress recognized the growing burden of federal student debt and began to offer borrowers a crucial protection that aligns monthly payments with a borrower’s earnings, rather than their loan balance. This set of repayment plans, broadly known as income-driven repayment (IDR), has been expanded and its eligibility criteria tweaked numerous times in the intervening years. Yet while it is an effective tool for many borrowers to avoid the most damaging consequences of taking on student loan debt, in many ways, IDR has failed to live up to its promise.
In part, this is due to intentional design choices by the Department of Education during the creation of various IDR plans. Borrowers in IDR who qualify for low monthly payments often face the frustrating experience of watching their balances grow over time because their monthly payments do not cover the interest on their loans, a process known as negative amortization. In addition, the structure of IDR plans often means that the unpaid interest that borrowers accrue can be capitalized, or added to the borrower’s loan balance, with the interest then accumulating even more interest. These expanding balances create a spiral of debt with negative consequences that ripple across borrowers’ financial lives, even in instances where IDR does make borrowers’ monthly bills more affordable. In other words, policymakers designed a system that assumed the amount of debt borrowers take on is largely immaterial, and the result is that millions of borrowers have been left to deal with the financial and psychological ramifications of decades of runaway debt.
In a new SBPC report, we outline how the choices made in implementing IDR and the financial fallout they have generated are keeping many borrowers in a debt trap, and what the Department of Education (ED) must do to break from previous efforts that failed to address runaway student loan balances and their effects.
Runaway Debt is Common and Disastrous for Borrowers
The experience of borrowers facing runaway balances is incredibly common and has affected more and more borrowers over time. IDR’s design implicitly treats these snowballing balances as insignificant, a simple technicality that will eventually disappear as borrowers complete the 20 or 25-year repayment period required to receive any forgiveness under their respective IDR plans. Yet the forgiveness under income-driven repayment has proven almost entirely theoretical thus far; a total of 32 borrowers out of well over 4 million have received forgiveness under any income-driven plan, and the Public Service Loan Forgiveness (PSLF) program, which requires borrowers to enroll in IDR as one of its eligibility criteria, has seen 98 percent of all applicants denied forgiveness.
Moreover, it is important to remember that even if forgiveness is realized for those who are able to navigate the bureaucratic nightmare of loan repayment for at least two decades (or more), the decision to allow for runaway loan balances is still potentially disastrous for millions of the most vulnuerable borrowers. Research has shown that the amount of student debt that a borrower owes matters on its own. Only assessing whether a borrower is burdened by looking at his or her monthly student loan payments misses a great deal, and in the process, ignores the very real pain millions of borrowers feel.
A borrower’s overall debt burden can impact their credit profile, income, and even career choices. Student debtors are also more likely to owe credit card debt or auto loans, and to show more signs of financial distress. In terms of homeownership, the impact of student debt on the ability to save for a down payment or be approved for a home loan further leaves behind those who are least likely to have wealth to overcome debt or avoid it in the first place. In fact, a typical borrower can pay tens of thousands of dollars in additional charges when attempting to finance a home, car, or use a credit card—just due to the damage that student loan debt does to borrowers’ perceived creditworthiness. The burden of student loan debt impacts mental andphysical health, and fundamentally changes whether a household feels like it is on secure financial footing. By ignoring all of this, and assuming that monthly payments are the most important measure of debt burden, policymakers have created a debt trap that falls most acutely on Black and Latino borrowers and communities, who must take on greater debt to finance higher education in the first place, and who are more likely to experience the shock of exploding loan balances.
It’s Time for Policymakers to Address IDR’s Flaws and Eliminate Runaway Debt
An equitable student loan repayment system that fulfills the promise of IDR would not pair the benefit of low, or even $0, monthly payment with the horror and financial damage of a balance that grows with no end in sight. And given that forgiveness under IDR has proven broadly elusive thus far, borrowers should not have to experience the anxiety of 20 years of repayment only to face a broken promise at the moment they expect to be rid of their debts. The experience of runaway loan balances was a policy choice, one that can be corrected by the Department of Education as it embarks on the latest round of negotiated rulemaking. In our report, we argue that ED should address the problem for borrowers by taking the following steps:
- Fully subsidizing unpaid interest for IDR borrowers and ensuring IDR borrowers’ payments reduce principal. Borrowers who make payments should see those payments have an effect on their debt, and those who qualify for $0 payments or need to pause their payments should not see their balances balloon while they get back on their feet. ED, through its rulemaking authority, should eliminate the phenomenon of negative amortization for borrowers in IDR by fully subsidizing any difference between a borrower’s calculated monthly payment and the interest owed on their loan for the full duration of a borrower’s time in any IDR plan. ED has previously used this authority, most recently in the design of the REPAYE plan, and it should expand this protection to ensure no borrower making a payment on their student loans sees their balance increase.
- Ending interest capitalization for borrowers, including those who leave IDR plans or fail to recertify income. ED, through its rulemaking authority, has the ability to address the fact that borrowers who leave an IDR plan or cannot recertify their income—often because of poor loan servicing—see their interest capitalized on their loans, costing them thousands of dollars. ED should end the practice of interest capitalization, including those who switch repayment plans or take advantage of other options within the loan program, such as deferment or forbearance, before or after enrolling in IDR.
- Cancelling a portion of principal for IDR borrowers who make low monthly payments for a certain period of time, and cancelling all unpaid interest charges accrued by borrowers who have used IDR since its inception. For borrowers who consistently have low enough incomes to make low, or $0, payments under IDR, the promise of debt-financed higher education has been broken. As it moves forward in addressing the demoralizing phenomenon of runaway interest, ED through its rulemaking authority should guarantee borrowers who are enrolled in IDR plans for a certain period of time, and meet certain income or monthly payment thresholds, see some of their loan principal automatically wiped away. This should also be retroactive: borrowers, including those who have been making low, or $0 monthly payments in IDR plans for a period of time, should see the unpaid interest that has accrued on their debts retroactively cancelled, and see principal forgiveness as well.
- Working across agencies to analyze inequities within the loan portfolio, including in who experiences negative amortization and interest capitalization. ED’s Office of Civil Rights (OCR) and the Consumer Financial Protection Bureau (CFPB) should collaborate to release data on the number and percentage of borrowers, particularly borrowers of color, who experience negative amortization, and the payment periods that borrowers of color face under IDR relative to white borrowers. These analyses can inform the current rulemaking and future policies about ending the practice of negative amortization and interest capitalization, and help policymakers and the public better understand the borrowers who are left further behind despite enrolling in IDR. Further, these analyses should include a look at the other debts facing IDR borrowers, especially IDR borrowers of color, in order to better inform the design of future repayment plans or broader student loan policy.
- Setting IDR payments at an affordable level. As SBPC documented in a recent report, IDR’s payment formula fails to deliver affordability and relief to too many borrowers, and leads to situations in which borrowers must choose between housing, healthcare, childcare, food, and student loan payments. As it works to address runaway debt and interest, ED should use its rulemaking authority to confirm that the current structure of monthly payments under IDR—including the current threshold of 10 percent or 15 percent of discretionary income, and the definition of discretionary income as up to only 150 percent of poverty guidance—is inappropriate for student loan borrowers. ED should increase the threshold of income that is protected from calculations that determine borrowers’ student loan payments under IDR.
It’s time for the federal government to do right by borrowers and stop the debt trap it created. This starts by recognizing that overall debt levels matter for borrowers, and correcting the mistakes of the past for borrowers who have lived through decades of an unfair system. By addressing negative amortization and interest capitalization, and removing the burden of interest for current and future borrowers, policymakers can begin to correct some of IDR’s key design flaws, help current and future borrowers, and build a student loan repayment system more in line with the principle that no borrower should ever experience runaway debt.
Read more on the SBPC’s work related to income-driven repayment here.
Mark Huelsman is a Student Loan Justice Fellow at SBPC. He is also currently a Senior Fellow at the Hope Center for College, Community, and Justice and previously served as Associate Director of Policy & Research at Demos.