Assessing the REAL Reforms Act: Rethinking Repayment

Editor’s Note: “Assessing the REAL Reforms Act” is a Minding the Campus symposium that is closely analyzing the Responsible Education Assistance through Loan (REAL) Reforms Act, a bill recently introduced by Representatives Virginia Foxx (R-NC), Elise Stefanik, R-NY, and Jim Banks (R-IN). The bill “offers commonsense and fiscally responsible reforms to benefit students and borrowers in our country’s federal student loan system.”

Each article in the symposium explores different sections of the REAL Reforms Act and features analysis by respected higher education experts. This piece is devoted to Sections 223 and 225, a summary of which we print below, followed by analyses by researchers Andrew Gillen and Preston Cooper. You may read the rest of the symposium here.

Title II—Loan Reforms

Sec. 223. Repayment Plans

Repayment Options for New Borrowers. Pares down the maze of repayment options to one standard 10-year repayment plan and one income-based repayment (IBR) plan.

Sec. 225. Income-Based Repayment Plan for Loans Made on or After July 1, 2023.

Secretarial Prohibition on New Repayment Plans. Prohibits the Secretary from creating new repayment plans, and from modifying an existing repayment plan in a manner that increases costs to the government.

Parent Borrower IBR Loophole. A current loophole allows parent loan borrowers to enter IBR if such borrowers consolidate a consolidation loan. This bill eliminates this “double consolidation” loophole for all loans.

Repayment Terms. Borrowers in the new IBR plan are required to repay the principal and interest they would have paid under a standard 10-year plan, as calculated when they entered repayment. The total cap protects against negative amortization, and thus caps the interest beyond what the borrower would have paid over 10 years (or the original repayment period in the case of a consolidation loan). The new IBR plan requires borrowers to pay 15 percent of their discretionary income and does not have an income cap or require borrowers to exhibit a partial financial hardship in order to qualify. Includes a mandatory minimum monthly payment of $25.

Eligibility Determinations and Notification to Borrowers. Aligns the new IBR plan with current law allowing for data matching for the purposes of certifying borrowers’ income upon implementation of the FUTURE Act.

Andrew Gillen, Senior Policy Analyst for Next Generation Texas, Texas Public Policy Foundation; Columnist, Minding the Campus

The first three reforms are beneficial and necessary, especially the simplification of repayment choices to just two options (the standard mortgage-like 10-year repayment plan and a new income-based repayment (IBR) plan). Currently, students have a maze of choices, which is unnecessarily intimidating and confusing, so simplification is a great idea.

The new IBR program also looks good. IBR is vastly superior to fixed payment plans for student loans since many students will experience short-term disturbances early in their career. On a fixed payment plan, these students might default due to short-term liquidity constraints, even if in the long term, they can afford the loan. By tying payments to income, IBR solves this problem, ensuring that payments are affordable for the student’s entire lifetime.

[Related: “Assessing the REAL Reforms Act: Ending PSLF”]

The 15% of income requirement is likely a wise choice. Early income-based programs required 20% of income. Most current plans require 10%, and Biden is proposing 5%. Given that the government is losing so much money on student loans (about $0.29 for every dollar it lends), 10% is too generous and 5% is moving in the wrong direction entirely. 15% may be a little too high or a little too low, but it is closer to being revenue-neutral (which should be the goal for government student loans).

The best part of the new repayment plan is the elimination of time-based forgiveness. Existing IBR plans forgive any remaining debt after 10 to 25 years of repayment—this is completely unnecessary. Income-based loans already ensure that payments are affordable, and they do so for the student’s entire lifetime, so there is no need to forgive the debt. In fact, these plans already have de facto forgiveness built in. If a student’s income is low, he doesn’t have to make payments—ever. What’s more, politicians have not been able to resist shortening the length of time before forgiveness, since they reap the political benefits from the change while sticking future politicians and taxpayers with the bill. For example, the first IBR program required 25 years of repayment. Under Biden’s new plan, it would be just 10 years.

I only have two concerns with Section 225.

First, the minimum payment of $25. I understand and generally agree with the desire to ensure that everyone is paying at least a nominal amount toward their loans, but this is largely a symbolic requirement. Yet if someone is unemployed with zero income, $25 could still be unaffordable, which means that some students will be forced into default over a symbolic gesture.

The other concern I have with the new plan is how it deals with interest. Rather than allowing interest to accrue on the unpaid balance, the new income-based plan essentially waives all interest and replaces it with a lump-sum equivalent to the amount of interest the student would have paid under the standard 10-year repayment plan. In other words, the student pays 15% of his discretionary income until he has repaid what he borrowed plus the interest he would have paid under the standard mortgage-like repayment plan. I have two objections to this approach.

First, IBR is already novel enough, such that changing the way interest operates unnecessarily complicates the plan. I think it would be better for both comprehension and public relations to let interest rates operate like they do for every other type of loan. Second, this approach to interest creates perverse incentives. The students who benefit are those who do not earn enough to repay their debt, who essentially receive a subsidy from the interest rate cap. At the same time, students with high earnings are essentially taxed, paying 10 years’ worth of interest even if their earnings are high enough to repay their loan in 7 years. In other words, the interest cap acts as an additional tax on sound educational investments that we would like to see more of, and a subsidy for educational malinvestments that we would like to see less of. Taxing good things and subsidizing bad things creates perverse incentives. This issue is easily remedied by replacing the interest cap with a standard interest rate.

While I would make small adjustments to the new repayment plan (dropping the minimum $25 payment and reverting to standard interest accrual), these reforms would be a dramatic improvement over the status quo.

[Related: “Assessing the REAL Reforms Act: Loan Limits”]

Preston Cooper, Senior Fellow, Foundation for Research on Equal Opportunity

Income-based repayment (IBR), which allows borrowers to cap their loan payments at an affordable share of their earnings, is an important component of the safety net for low-income people with student debt. But the Obama and Biden administrations have repeatedly made the program more generous, now to a fault. President Biden has proposed to cut loan payments to just 5 percent of borrowers’ earnings above 225 percent of the poverty line, meaning even middle-class borrowers could get a $0 monthly payment.

The REAL Reforms Act restores an older version of IBR, which assessed loan payments at a rate of 15 percent of earnings above 150 percent of the poverty line. This is low enough to ensure affordable payments for low-income borrowers but asks middle- and high-income borrowers to pay what they owe.

Critically, the plan also introduces a cap on total payments. One of the flaws of IBR is the fact that borrowers with low payments might not cover their interest, which if left unchecked can cause balances to balloon. The bill would fix this problem by capping lifetime payments; even if unpaid interest accrues, borrowers will never owe more than they would have paid under the 10-year standard plan. This change will offer comfort to borrowers who need an affordable payment but worry about uncontrollable balances.

Image: Adobe Stock


One thought on “Assessing the REAL Reforms Act: Rethinking Repayment”

  1. What about trust funds?
    What about deferred compensation?

    The advantage of income-based repayment is that current income can be (and often is) shifted to future years. While this is usually done because one will be in a lower tax bracket then, what prevents it from being done here?

    Is there any asset test for income-based forgiveness?

    And as an aside, most college presidents have deferred comp arrangements.

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