Don’t Overlook These Key Details of Student Loan Forgiveness

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Written by: Eric Syverson
Aug. 31, 2022

After months of speculation, President Joe Biden announced his administration’s plan for student loan forgiveness. Although many reactions focused on how the plan cancels student debt for tens of millions of borrowers — $10,000 for those making less than $125,000 in 2020 or 2021 and $20,000 for Pell Grant recipients — and extends the pause on student loan payments through the end of 2022, the notice contained significant changes to income-driven repayment plans (IDR) in recent memory. In turn, many have begun to speculate how changes to financial assistance could positively impact postsecondary enrollment and completion.

Since 2009, borrowers could sign up for IDR plans that were designed to cap monthly payments to 10% of income and cancel remaining debt after 20 years of monthly payments. However, many researchers have long lamented that IDR plans were too complicated, which limited the number of borrowers who signed up for them. The announcement attempts to address these concerns by:

    • Cutting monthly payments in half. Borrowers who sign up for IDR plans with undergraduate loans will now pay 5% of their discretionary income instead of 10%. In addition, the rule proposes raising the amount of income considered non-discretionary to 225% of the federal poverty level — or $30,578 annually for an individual.

Taken together, these rule changes mean any borrower making below that amount will not have to make a monthly payment and, for those with higher incomes, their payments would be 5% of their income for each dollar made above $30,578. Raising the amount the government considers non-discretionary income comes at a time when inflation is increasing costs for household necessities like child care, groceries and gas.

    • Ending interest capitalization for monthly payers. As a result of current IDR policy, a borrower’s loan balance accrues interest more than standard repayment plans. By design, lower monthly payments and longer repayment periods cause interest to grow when payments are less than the amount of interest due monthly. The proposed rule requires the U.S. Department of Education to cover unpaid monthly interest so that no borrower’s loan balance will grow if they make monthly payments. Crucially, this change also applies to borrowers with incomes below 225% of the poverty level — whose payment is $0 per month.
    • Forgiving IDR plans faster. Under current law, the government forgives loan balances after 20 years of payments. The proposed changes will halve that time for borrowers with an original loan balance of $12,000 or less so that their entire balance is forgiven after 10 years of payments.

All told, these proposed reforms aim to decrease borrower’s monthly payments. The last change in particular is highly relevant for state policymakers, as the average tuition and fees for public two-year institutions is $3,800 and the net cost of attendance is $14,370 as of 2021. This change alone will afford many students at community colleges and career and technical institutions to be debt free within 10 years of low or no monthly payments. Aside from impacts on students’ budgets, some researchers warn that these changes could incentivize institutions to raise tuition rates since students may take out more financial assistance.

Considering the significant postsecondary student enrollment declines institutions have experienced since the start of the COVID-19 pandemic — which have acutely affected two-year institutions in particular — structural change to federal student loans may be coming at the right time. Combined with state and local governments increasingly offering college promise programs for two-year institutions, these rule changes have added another tool for state policymakers to encourage students to pursue postsecondary credentials.

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