Are Income-Driven Repayment Programs Putting Federal Student Loans at Risk?

income-driven repayment programs

Federal student loans are costing the government billions of dollars, according to a recent report from the Office of the Inspector General at the Department of Education.

The report states that the biggest culprit is the growing number of borrowers who enroll in income-driven repayment programs (IDR). These programs allow students to extend their student loan terms and make monthly payments based on how much money they make.

This report follows one from the Government Accountability Office (GAO) in 2016 indicating that the federal government drastically underestimated the cost of income-driven repayment.

It is likely that this new report from the Office of the Inspector General will influence the outcome of the PROSPER Act legislation currently working its way through Congress.

Income-driven repayment programs cost the government $11.5 billion in 2015

According to the Office of the Inspector General, the government subsidy for income-based repayment plans such as Pay as You Earn (PAYE) and Revised Pay as You Earn (REPAYE), rose from $1.4 billion in 2011 to $11.5 billion in 2015.

income-driven repayment programs

Image credit: Office of the Inspector General, U.S. Department of Education

The above figure shows that the government has been making money on all other federal student loans. However, when it comes to income-driven repayment programs, the government is losing money. The red line indicates the total — and the trend appears to be moving in a direction where the money repaid by borrowers will no longer offset the cost of student loan forgiveness.

“Borrowers have been signing up for IDR plans, such as PAYE and REPAYE, at a substantial rate,” said the report. “We calculated that the portion of total Direct Loan volume being repaid through IDR plans has increased 625% [from 2011 to 2015].”

The Office of Federal Student Aid (FSA) is also recognized in the report. “As more borrowers select IDR plans that allow for student loan forgiveness, the cost of this form of nonpayment could be a major issue for the federal government.”

On top of that, FSA expressed concern that uncertain repayment terms related to timing and the potential for more forgiveness could create challenges to managing the government’s student loan portfolio.

A similar report from the GAO in late 2016 took the Department of Education to task for severely underestimating the cost of income-driven repayment programs and Public Service Loan Forgiveness (PSLF). That report found that close to one-third of federal student loans expected to go through IDR would be forgiven, at the cost of $74 billion for student loans issued between 2009 and 2016.

What does the Office of Inspector General recommend?

To help alleviate this problem, the Office of Inspector General suggests that the Department of Education take the time to publish more information about the costs. The GAO already asked the Department of Education to improve the way it estimates the impacts of policies.

“[I]t is imperative that the department publish additional information on both historical and future estimated costs and the associated assumptions, methodologies, and limitations of the information,” said the report, giving the Department of Education 30 days to submit an action plan to correct the situation.

The Obama administration pushed for increased publicity for income-driven repayment programs as a way to help low-income students better manage their cash flow. However, even with that push, in May 2017, the Consumer Financial Protection Bureau published findings indicating that many servicers aren’t providing information about IDR options and that some borrowers find it difficult to enroll.

How could the PROSPER Act impact the growing cost of income-driven repayment programs?

While the Department of Education looks at its methodology and attempts to find a solution to its federal student loans portfolio woes, Congress may already be taking steps to solve the problem, courtesy of legislation wending its way through the House and the Senate.

In December, the House introduced the PROSPER Act, and the Senate has been holding hearings about the legislation.

If passed, the PROSPER Act would streamline the repayment program to include a standard 10-year plan and a single income-based repayment program. However, with the new plan, there would be a minimum payment of $25 and borrowers would pay 15% of their discretionary income.

This is a change from current programs that allow for no minimum payment if students have low enough incomes, as well as raising the cap from 10% of discretionary income.

On top of that, the PROSPER Act reduces the loan amount eligible for forgiveness. Borrowers would be required to pay whatever they would have under a 10-year plan, getting rid of any forgiveness for principal loan amounts. There would be forgiveness of any interest that accumulates beyond the interest a borrower would have paid in a standard plan, though.

However, the reduction in the amounts forgiven could help stem the tide of growing costs to the federal government.

“One of the strongest policy reforms in the PROSPER Act is the elimination of loan forgiveness,” said the right-leaning Heritage Foundation. “Ending this policy would come as welcome news to American workers, the majority of whom do not hold bachelor’s degrees and will currently have to pay this massive bill along with any new loan forgiveness.”

The left-leaning Center for American Progress, however, worries the PROSPER Act could hit low-income graduates hard — and even cost them more in the long run.

federal student loans

Image credit: The Center for American Progress

Additionally, the PROSPER Act has no upper limit on the repayment term. Even though excess interest would be forgiven, the fact that the original amount borrowed must be repaid means that some borrowers could continue paying for 60 years, according to the analysis.

“While the desire to reduce complexity for borrowers is laudable, the PROSPER Act would do more than good,” said the Center for American Progress. “The repayment restructuring would increase monthly payments for all borrowers, increase the amount many borrowers will pay overall, and increase the time they will spending doing it.”

What can you do about your student loan situation?

Since their introduction, income-driven repayment programs have provided a way for borrowers to stay current on their payments without breaking their budgets. For now, IDR makes sense when you need increased monthly cash flow.

However, long-term, it’s possible that you could end up paying more than you borrow, depending on how long you are in repayment. The longer you pay interest, the more it will cost you. Plus, current IDR solutions can potentially result in a hefty tax bill after your remaining balance is forgiven 20 or 25 years down the road.

For many borrowers, especially those who don’t qualify for PSLF, it might be a good idea to find ways to pay down debt faster. As your income increases, consider making larger payments, or even refinancing to a lower interest rate and term, to help you get rid of your debt ahead of time — and pay less doing it.

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