President Obama recently announced a new push to enroll people with outstanding student loan debt in programs that make it easier to pay back. Specifically, the Department of Education is promoting so-called “income-driven repayment” plans, where borrowers do not make a fixed payment every month, but instead contribute a certain portion of their income towards their student loan balance. These plans are not new—the White House’s initiative is mostly to raise awareness.
It is a good idea in theory, and will certainly make payments more manageable for borrowers. However, the scheme has one major problem for taxpayers: if students have not repaid their loans in full at the end of a fixed period (generally 20 or 25 years), any remaining balance is forgiven. Those who borrow the most receive a massive taxpayer subsidy.
President Obama’s latest push may be unnecessary, as income-driven repayment plans have become far more popular in recent years. In the last two years, the share of federal Direct Loan borrowers enrolled in income-driven repayment plans has doubled from 11 percent to 22 percent. The share making level payments (a fixed amount every month) or graduated payments (payments which go up with time) has declined from 84 percent of borrowers to just under three-quarters. People with student loans are rapidly learning about these plans, and using them.
In principle, income-driven repayment is a good way to pay back student loans. Since college is an investment that leads to higher earnings down the road, it makes sense that students who see a higher return on investment (a higher income) should pay more than those for whom the investment fails. Stocks are a good parallel—traders invest a certain amount in a company, and receive higher or lower returns depending on how the company performs. This idea of financing college through “student equity” rather than student debt dates back to Milton Friedman and has counted former Governor Jeb Bush and Senator Marco Rubio among its modern proponents.
The trouble is that under the current design, students often will not pay back the full balance of the loan, due to loan-forgiveness at the end of a 20- or 25-year period. We do not yet have good data on how many students will utilize this provision, but Department of Education calculations show that a typical undergraduate borrower could receive around $25,000 in loan forgiveness.
Read the entire piece here at Forbes
This piece originally appeared in Forbes