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Published: Mar 21, 2016 7 min read
Photo illustration by Sarina Finkelstein for Money; Getty Images (2)

Student debt is a hot topic in the press and on the campaign trail. The general consensus is that this debt is “crushing” a generation and that the federal government should take action to solve the problem.

A policy proposal with support from a wide range of ideological perspectives is to strengthen the income-driven loan repayment (IDR) system, which allows borrowers to repay affordable amounts based on their incomes, rather than expecting fixed payments every month regardless of the financial circumstances in which borrowers find themselves.

A broad-based plan of this type has been in place in the U.S. since 2007, and several additional income-driven plans have recently become available, each more generous than the last. This approach has the potential to relieve many of the problems in the student loan system, virtually eliminating default and making the stories of former students oppressed by their debt burdens much rarer than they are now.

But designing a strong IDR system is challenging. The details might sound technical, but they can make a real difference in the lives of students and the burden facing taxpayers. It helps to begin by reviewing the purpose of this type of loan repayment system.

Going to college pays off very well—both financially and otherwise—for most people. The average returns are much higher than they were in the past and higher than the returns on other forms of investment. But there is a lot of variation in college outcomes, and it doesn’t pay off so well for everyone. This can be a problem whether or not the student borrowed, but the immediate challenge of repaying loans out of an inadequate income can lead to serious difficulties. Income-driven repayment is a form of insurance against this outcome. If you don’t have the money now, you can postpone the payments until you can afford them. If that day never comes, you will never have to pay.

Fairer to students and taxpayers

This sort of insurance is not the same as making sure that all borrowers make the lowest possible payments. If borrowers do not repay their loans, taxpayers are left holding the bag. Student loan holders are far from the neediest segment of the population. In fact, about half of all outstanding student loan debt is held by households in the top quarter of the income distribution. This is not surprising, since high levels of debt correspond to high levels of education, which correspond to high earnings.

Some key factors that will make for a fairer and more successful system include the following:

  • All borrowers should be automatically enrolled in IDR so they do not face bureaucratic hurdles to gaining this protection.
  • Loan payments should be withheld from paychecks so they adjust easily to changes in earnings and so that borrowers actually make the payments their incomes will support.
  • There should be limits on how much debt can be enrolled in the program, eliminating the current problem of graduate students borrowing unlimited amounts, with additional borrowing often having no impact on how much they will eventually repay before the balance is forgiven.
  • The policy design should avoid “cliff effects”—bright lines between groups of people that result in very different treatment of people in similar circumstances. An example is adding five years to the amount of time borrowers have to make payments before having their unpaid balances forgiven if they have even a small amount of graduate school debt. It would be preferable to extend the years of repayment gradually as the total amount of debt rises.

The problem with grad students

A real problem with the current system is that it is overly generous to graduate students, who can borrow virtually unlimited amounts from the federal government. Even doctors and lawyers with relatively low incomes for their professions—but high incomes relative to most other people—can end up having debts forgiven if they have borrowed extensively. Because payments are a function of income only, and not of the amount owed, taking out extra loans to fund graduate education may well not increase the amount a borrower repays before having the remainder forgiven.

Best college education image

To address this problem, some advocates have suggested approaches such as having people with debt above, say, $50,000 pay at a higher rate or for a longer period of time than people with debt of $50,000 or less. Under the recently implemented REPAYE plan, undergraduate borrowers have their remaining debt forgiven after 20 years of repayment, but those with any graduate debt at all must repay for 25 years. In other words, two borrowers with identical debt levels, one of whom has a small amount of graduate school debt, will repay very different amounts. Students’ decisions about whether to go to graduate school should not depend on such arbitrary differences.

Similarly, charging one interest rate to students who received Pell Grants and a higher rate to other borrowers could mean that a very small income difference in college would lead to hundreds of dollars of difference in the total amount of debt repayment.

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A fundamental rule of good public policy design is the avoidance of such cliff effects, which are unfair and create wasteful incentives to get to the other side of the line.

Income-driven repayment is a good solution to many of the risks of student debt. But most borrowers should eventually repay their debts, even if they must postpone payments when they hit rough spots. The system should be as simple as possible and protect borrowers facing unforeseen hardship, without letting those who can reasonably repay their debts avoid the responsibility.


Sandy Baum is a senior fellow at the Urban Institute. She has written extensively about the economics of higher education.