Pay Long and Don’t PROSPER

How the New House Student Loan Repayment Plan Could Hurt Borrowers

This November 18, 2016, photo, shows the U.S. Capitol dome at sunset on Capitol Hill in Washington.

Increasing rapidly in enrollment in recent years, income-driven repayment (IDR) plans allow borrowers to pay a fixed portion of their income each month, making loan payments more predictable and more manageable for many. And for borrowers whose incomes do not exceed a level required to meet their everyday needs, IDR does not ask them to pay anything until they are back on their feet.

However, the House proposal to overhaul the Higher Education Act (HEA) would upend the most important protections for low-income borrowers using IDR, eliminating much of the value for the students who need it most. The bill, called the PROSPER Act, increases monthly payments and eliminates the current fixed forgiveness point. It also adds a minimum monthly payment, whereas the Obama-era plans allow for borrowers at certain incomes to pay nothing at all, recognizing that other demands on their income such as food and housing should take priority. As a result, many low-income borrowers pay a great deal more over a much longer repayment period. And for all the concern the bill’s authors have expressed about the “maze of loan repayment options,” the PROSPER plan adds many complexities of its own.

To demonstrate the effects of the Republican proposal for IDR, this column simulates the repayment experience of nearly 26,000 debt and income combinations to get a rough picture of the consequences for borrowers of all types. The picture is grim: some low-income borrowers would face overall repayment increases of tens of thousands dollars relative to the two newest available IDR options. Those same borrowers can also expect to spend more time—several decades more for the lowest-income among them—on repayment the options they would likely use if they were borrowing today.

Income-driven repayment is not without its flaws. The income information the plan uses is outdated, and if a borrower experiences a sudden drop in her hours or loses her job, she must proactively alert the federal government about the change to their income to get a payment reduction. The plans also require that borrowers submit paperwork each year to remain enrolled, a step that can trip up borrowers. These process issues could be fixed by new policy, but the PROSPER Act does nothing to address them.

How would the House plan change repayment?

The House bill would start by ending all current IDR plans for borrowers who take out their first loan after the law took effect, including the two newest IDR options, Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE). These plans ask borrowers to pay back 10 percent of their discretionary incomes—the amount of income above 150 percent of the poverty level for a borrower’s family size—each month. Borrowers make payments until they pay off their debt or reach forgiveness, which happens after 20 or 25 years, depending on the plan. A borrower with no discretionary income is not expected to pay anything.

As Table 1 shows, the PROSPER Act would change this framework in a few ways. In perhaps the biggest change to IDR, the law would eliminate the fixed 20- or 25-year forgiveness horizon. Instead, the PROSPER Act would require borrowers to continue paying until they have paid as much as they would have paid on a standard 10-year fixed payment plan.

The new law would also require borrowers to pay 15 percent of their discretionary income, up from 10 percent under PAYE and REPAYE. And instead of offering low-income borrowers $0 monthly payments, the bill adds a minimum monthly payment of $25.

The PROSPER Act would also change the treatment of unpaid interest. Because IDR allows borrowers to make payments that are lower than the amount of interest that accrues in a given month, policymakers must decide how to treat the interest that goes unpaid. On PAYE and REPAYE, some interest is forgiven while the borrower is in repayment, depending on the plan and the type of loan. However, under the House Republicans’ plan, no such interest accrual protections exist, and borrowers must repay any unpaid interest. Because borrowers must always repay any unpaid interest before paying down their principal balance, accumulating interest makes it harder and harder to make progress on a loan over time. And if a borrower cannot reduce their principal balance, she cannot reduce the amount of interest that accrues, resulting in a hole that is hard to dig out of. Though the PROPSER Act claims to fix this problem by limiting the total amount a borrower can repay, this upper limit mostly helps the highest income borrowers and comes with the side effect of forcing many other borrowers to pay back much more than they otherwise would.

So what would these changes mean for borrowers? In its promotional materials for the bill, the PROSPER Act’s authors tout the plan’s commitment to making sure that borrowers need pay “only the principal and interest they would have paid under a standard 10-year plan.” Framed this way, the bill’s authors portray PROSPER’s repayment plan as a cost-saving policy for borrowers. In reality, however, the plan means that borrowers get to pay less than much less often than they would on the standard plan. This new requirement functions more as a floor than a ceiling.

The truth is that many borrowers—especially those who are low-income—are not in much danger of paying back more on current IDR plans than they would on the standard plan. The so-called protection that the PROSPER Act offers is therefore not of much value for them. Under PAYE and REPAYE, borrowers always have a 20- or 25-year finish line for their repayment term. Under this proposal, students would need to keep paying until they have paid off under the terms of IDR or have paid what they would have on the 10-year plan. For many borrowers, the result is a much bigger overall repayment bill.

Many borrower types would be expected to pay significantly more

This column simulates the repayment experience of nearly 26,000 debt and income combinations. These simulations take each $500 increment of income between $0 and $100,000 and combine them with every $500 increment of debt between $1,000 and $65,000. One can imagine each combination as a borrower who enters repayment with that amount of debt and earning that income. The simulations project their repayment experience using the rules of REPAYE and the PROSPER Act, as well as some simple assumptions about the growth of their incomes and the economy. We also assume that only those borrowers who would have a lower monthly payment on IDR than the standard 10-year plan will enroll in an IDR plan. We exclude borrowers who would have a higher monthly payment on IDR from the figures below.

As Figure 1 shows, borrowers with many different combinations of income and debt would be on track to repay a great deal more under the PROSPER ACT than on REPAYE. Here we see that virtually all borrower types with starting incomes below $15,000, roughly the bottom quartile of all borrowers entering repayment in 2014, would see an increase in their payments. For the lowest income borrower types, who would be expected to pay nothing throughout much or all of repayment on PAYE, the growth in what they pay comes in large part from the imposition of the $25 minimum payment. For the borrowers with incomes between $3,500 and $32,500 and debts above $23,500, those in the yellow and orange shaded areas, the PROSPER Act would mean such borrowers pay back at least $15,000 more, and in some cases upwards of $30,000 more, than they would on REPAYE.

In contrast, borrowers with relatively high incomes would see the amount they pay go down on the PROSPER Act’s plan. Depending on their level of debt, these borrowers may derive savings from the higher monthly payment, as happens with the plan’s requirement that borrowers pay 15 percent rather than 10 percent of their income. This higher payment causes them to pay their debt down faster and accrue less interest relative to REPAYE. They may also derive savings from the House plan to cap total repayment at the 10-year standard amount. These instances occur when a borrower pays slowly enough to accrue interest more quickly on the new plan than they would on the standard plan. Because they will accrue more interest overall, these borrowers are prevented from paying off all of their principal balance, as that would result in a total paid higher than the standard plan.

The potential to pay until you die 

Because there is no upper limit of a borrower’s repayment term, some low-income and high-balance borrowers will remain in repayment until death. Figure 2 shows the difference in the number of years we project that borrowers would spend in repayment on the PROSPER plan relative to REPAYE.

Low-income borrowers would again lose out most; in some cases, their repayment time would increase by more than half a century. But even the less extreme jumps in repayment time are quite dramatic. Some debt and income combinations where the borrower starts out earning nearly $20,000 could see an extension of their time in repayment of over a decade.

To be sure, some borrowers do see a reduction in their time in repayment on the PROPSER IDR plan. Borrowers who see a reduction, however, typically started out earning relatively high incomes and they repay faster either because of the limitation that they could not pay more in total than that paid over the standard 10-year plan or because they pay more each month. Low-income, low-balance borrowers spend much less time in repayment on the PROPSER plan because the $25 minimum payment means they begin paying down their debt right away, rather than making $0 payments as they would on REPAYE. This leads them to spend less time in repayment because they pay off much more quickly.

Solving one problem while creating another

Aside from the new IDR plan’s increased costs for borrowers, it is worth noting how much more complicated the PROSPER Act would be from a borrower’s perspective. Currently, borrowers on IDR know that they will be done repaying in 20 or 25 years at most. Under the PROSPER proposal, borrowers would need to keep track of both how much they have already paid and how much is left to pay. This information would then need to be combined with the amount they would pay back in total on a 10-year standard repayment plan and the amount they expect their earnings to increase, including any changes to their household size or possible spells of unemployment, to determine roughly when they could expect to finish repaying their loans.

Additionally, low-income borrowers facing unemployment or high medical costs would have to jump through hoops in order to get their minimum payment temporarily reduced from $25 to $5. If the borrower can prove she is unemployed and diligently searching for a job, she can have her payment reduced for up to three years. If the payment reduction comes because of high medical costs, the borrower is again limited to three years of reductions and must also provide evidence every three months that the costs are still a burden.

Back to the drawing board

While the desire to reduce complexity for borrowers is laudable, the PROSPER Act would do more harm than good. The repayment restructuring would increase monthly payments for all borrowers, increase the amount many borrowers will pay overall, and increase the time they will spend doing it. This effort is far from the reform borrowers need. Instead, any meaningful reform to IDR plans should address the process problems that make enrolling and staying enrolled in IDR difficult.

Automatic annual recertification could go a long way to making sure students do not get bounced from the plan for failing to fill out paperwork each year. And using payroll withholding as a way to calculate payment amounts and facilitate their delivery could ensure that borrowers with variable hours or frequent spells of unemployment could keep payments well-tailored to current income. While all of these potential changes to IDR would require careful consideration, they demonstrate the types of pressing concerns facing borrowers that get ignored by the PROSPER Act.

But perhaps more important is a reminder of the motivating principle behind income-driven repayment. Income-based plans are a form of insurance for the risks inherent to making a debt-financed educational investment. Borrowing money to improve your education level is a great investment in the aggregate. As a society, we clearly benefit from a more educated and higher-income populace. But in any individual case, taking on debt for education can be a risky bet; life has its ups and downs, as does the economy. So how does society convince risk-averse individuals to make an investment that typically more than pays off, but still has the potential to go sour? We provide a way to minimize that risk: A progressively structured income-driven repayment plan. If the educational investment works out for a student, and he earns a higher salary than he otherwise would have without his degree, he pays back his loan and chips in a bit extra for those who took the risk along with him but had worse luck. If going to school does not work out, then he is protected and only needs pay as much as he can, even if that amount is $0.

If our society and economy are going to grow and flourish, it is crucial that we enable students to invest in themselves. An attempt reform to IDR programs is an excellent step, but the PROSPER Act is a step in the wrong direction.

Methodology

To calculate a borrower’s experience on IDR throughout repayment, we make a few simplifying assumptions. In particular, we assume borrowers have loans with a 5 percent interest rate; an income that grows by 5 percent each year; and that the poverty level increases by 2 percent each year. We also assume that the borrower pays continuously and in full in each period and that the borrower is the lone individual in their household. Additionally, because there would be no limit on how long a borrower can remain in repayment under the PROSPER plan for IDR, our calculations assume an artificial limit of 75 years in repayment. This means we undercount how long a borrower could be paying back their debt if they reach 75 years in repayment and have not either paid an amount equal to the 10-year standard amount or paid off their debt on the IDR terms. However, we will overcount the amount of time a borrower will spend on repayment if he is not alive for 75 years of repayment and has not retired his debt or reached forgiveness by the end of his life. All dollar values presented in this column are discounted using a rate of 2.8 percent. In addition, in this column we only present results for the PROSPER Act plan compared to REPAYE, but in results available in the replication packet we show the results for PAYE, which are quite similar.

To learn more about or replicate our findings, you can find our detailed Stata code here.

CJ Libassi is a policy analyst of Postsecondary Education at American Progress.