Fixing the Student Loan Safety Net

Many believe the United States is in the midst of a student debt crisis. With outstanding federal student loans at $1.6 trillion, mass loan forgiveness proposals have garnered public attention and support from prominent politicians. But there’s a glaring omission in the debate about unaffordable student debt: the existing Income-Driven Repayment (IDR) program. Though far from perfect, this program goes a long way towards solving any student loan crisis among distressed borrowers — and it provides loan forgiveness. Do we really need a debt jubilee, too? Hardly. But as we show in a new American Enterprise Institute report, that doesn’t mean we should do nothing. 

First, let’s consider how IDR helps ensure borrowers aren’t overwhelmed by their student loans. Most people with federal student loans have access to the program and therefore can elect to cap their monthly payments at 10% of discretionary income. This significantly reduces payments even for borrowers with average amounts of debt. A single adult earning $35,000 per year would normally pay $304 a month on a $30,000 loan on the standard repayment plan. But enrolling in IDR lowers her monthly payments to just $131. These lower payments will put her at much lower risk of default or other financial distress.

The Department of Education estimates that the average monthly payment for borrowers using IDR is around $154. But that statistic masks another feature of the program. Since payments are based on discretionary income, not total income, many borrowers qualify for monthly payments of zero. 

These facts stand in stark contrast to the idea that policymakers have not provided borrowers with avenues for debt relief. In fact, millions of borrowers are taking advantage of IDR. Income-driven plans for federal student loans have existed in one form or another since 1995, but were not originally available to all borrowers and reduced payments only slightly. That changed in 2012, and since then IDR has exploded in popularity. More than eight million borrowers repay over $500 billion in loans through IDR. Since 2013, the absolute volume of loans in IDR has increased 600%.

IDR also offers borrowers a loan forgiveness benefit, but it is more targeted than a debt jubilee. Loans are forgiven only after borrowers make income-based payments for a set period of time, typically 20 years. This rule helps to determine whether a borrower has a long-term financial challenge in repaying their debt or only a temporary hardship, with forgiveness provided only to the former group; someone with a temporary hardship would most likely repay the debt before 20 years.  

Despite IDR’s targeted loan forgiveness benefits, the program still provides more relief to the lowest income borrowers than some versions of debt jubilee. An empirical study by Sylvain Catherine and Constantine Yannelis finds that low-income households would, on average, benefit more from universal enrollment in IDR than they would from the $10,000 in forgiveness proposed by President Joe Biden. 

This suggests that loan forgiveness advocates could significantly reduce distress among low-income borrowers if they turned their efforts instead toward boosting IDR enrollment among this population. Moreover, such efforts would cost a fraction of mass loan forgiveness.

There’s another reason why we should invest in boosting IDR enrollment among low income borrowers: they aren’t using the program as much as other borrowers. 

The borrowers most likely to enroll in IDR are those who racked up large debts at graduate and professional school. Over two-thirds of loan dollars in IDR belong to people who borrowed for these degrees, and 80% of the $200 billion projected to be forgiven in the next decade will go to these borrowers. Graduate borrowers, however, tend to have the highest incomes and the lowest loan default rates. They still reap outsized benefits from IDR because their debts are so large relative to the repayment and loan forgiveness terms.

IDR plays a critical role in the student loan system, but it needs reform. We recommend a two-pronged approach. First, policymakers should improve the safety-net features of the program for low-income borrowers and increase enrollment among vulnerable populations. Second, the government should curtail the excessive benefits that flow to high-balance borrowers.

For borrowers with low balances and low incomes, we recommend that loan forgiveness occur after 10 years of payments rather than 20. To pay for this new benefit, the government should extend the forgiveness mark for borrowers with graduate school debt to 25 years. In addition, Congress should limit how much debt graduate students can take on in the first place.

The public debate over student loans centers around whether the government should cancel borrowers’ debt, and how much. That’s the wrong approach. Instead, policymakers should recognize that IDR already provides loan forgiveness and an important safety net for millions of borrowers. Policymakers should also focus on how they can improve the program and better target resources to individuals most in need.

Jason D. Delisle is a visiting fellow at the American Enterprise Institute, where he works on higher education financing with an emphasis on student loan programs.

Preston Cooper is a visiting fellow for higher education policy at the Foundation for Research on Equal Opportunity.