Recent changes to a repayment option for federal student loans – intended to help low-income borrowers – favor high-income borrowers with high debt instead, according to a report released last week.
According to two researchers with the New America Foundation, a non-profit and nonpartisan policy research institute, the changes, passed by Congress in 2010, do little to help low-income borrowers. They also can erase hundreds of thousands of dollars of debt for higher-income borrowers – money those students otherwise would have paid back to the government.
“It sort of indiscriminately provides benefits,” said Jason Delisle, one of the study’s authors, in an interview with Yahoo! Finance. In the report, he and colleague Alex Holt said students have little to lose for borrowing more once they hit $60,000 in debt.
“The more you borrow, the more you can have forgiven,” Delisle said.
The study focused on income-based repayment, a system that allows student borrowers with a lot of debt, when compared to their income, to make lower monthly payments on federal loans.
When it started in 2007, IBR allowed students to cap their monthly payments at 15 percent of their disposable income. It was meant as an alternative to defaulting on loans, which can stick with a student for life.
Students qualify for IBR only if that percentage means a lower monthly payment. If their incomes rise above this threshold, they’d switch back to a standard payment amount. After 25 years, if the borrowers still owe money, that debt is forgiven, with quicker forgiveness for those who take public service jobs.
In response to the recession and ever-rising student debt, Congress changed those rules in 2010 so payments would be 10 percent of disposable income and debt would be forgiven after 20 years. Those changes will likely come into effect by the end of the year.
To be clear, the report emphasized that IBR works fine as intended: a safety net for low-income graduates, even those with very high debt.
These changes, however, only cut those students’ payments by a few dollars a month because their income is already so low. High-income borrowers – even those earning six figures – have much more to gain if they also have high debt, the report says.
“The program is set to provide huge financial windfalls to people who, far from being needy, are among the most financially well-off graduates in today’s job market,” the authors wrote.
For example, take medical students who graduate with $250,000 in debt but earn $100,000 their first year. According to the foundation’s IBR calculator, available at edmoney.newamerica.net, those borrowers could pay back about $200,000 less under the new rules than under the old and have even more debt – $400,000 – completely forgiven.
Even if their income rises rapidly, if forgiveness is set five years sooner many similar graduates will never be disqualified for IBR and never pay everything back, the report says.
Meanwhile, the average graduate from the University of Nebraska-Lincoln, earning about $36,000 the first year and with about $22,000 in debt, would actually pay about $10,000 more under the new rules because it would take longer to pay the loans off with lower payments.
That seems like a clear break for high-income students, but it comes with a limit.
According to that same calculator, for example, if graduates making $100,000 have the same amount of student debt, the new IBR rules actually have them paying about $50,000 more, thanks to accumulating interest, than under the old rules. No matter how much graduates make, their debt must always be much more.
“It’s all relative,” said Craig Munier, director of UNL’s Office of Scholarships and Financial Aid and chairman of the National Association of Student Financial Aid Administrators. “Even though you’re making a lot of money, you still have a very high loan debt.”
One reason the researchers gave for the disparity between income brackets is the percentage of income used to calculate monthly payments. They’re based on adjusted gross income, which can be lowered with various tax deductions like retirement and health care savings.
The researchers argue high-earners can afford to contribute more to those savings than low-income graduates. But that’s not so clear, said UNL economics professor John Anderson. Many deductions shrink with higher income, for example, meaning high-income borrowers have less to gain.
“It’s probably not fair to say these deductions all work in favor of high-income taxpayers,” Anderson said. “I’d be careful.”
Overall, the researchers suggested a two-tier compromise: keeping the old rules for incomes at or above 300 percent of the poverty level – about $33,000 for an individual living alone – while putting in the new rules for income-earners below that line.
“I think they have some valid points,” Munier said. “I think that warrants some further study.”