A promising modification in the way students pay for college is income-contingent loans that allow for flexibility in loan repayment on the basis of post-college income flows. This arrangement greatly reduces the risk of default faced by students borrowing to finance their educations, and therefore may increase college matriculation and persistence among risk-averse and economically disadvantaged students. The College Cost Reduction And Access Act of 2007 makes federal student loans eligible for income-based repayment as of July 1, 2009, where payments are limited to either 15 percent of the borrower’s monthly discretionary income or 15 percent of the amount to which the borrower’s monthly adjusted gross income exceeds 150 percent of the federal poverty line.
The Department of Education is tasked with conducting annual verifications of the borrower’s debt balance and income, and after 25 years any remaining debt is forgiven. While appealing, a major concern with a program of this type is the issue of moral hazard, whereby an individual who is insulated from risk might begin to adopt riskier behaviors. An adequately funded study of this program—experimenting with different requirements for eligibility and different amounts of aid—would provide information on how serious an issue moral hazard may be and thereby greatly advance the debate on the worthiness of this repayment option for increasing educational attainment.
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