Income-Driven Loan Repayment: Worth the Cost of Subsidized Loans?

July 17, 2014

Carrie Warick, Director of Partnerships and Policy

Congress has been busy introducing student loan improvements over the past few weeks. Three of the proposals are highlighted in this comparison chart on the Higher Education Act and Senators Warner (D-VA) and Rubio (R-FL) introduced another option yesterday. Many of these proposals work to simplify the student loan program, both through simplifying the loan programs and through simplifying the loan repayment options. Overall, the critics of the federal student loan program argue that both the options for loans, and the even more plentiful number of repayment options make the program too complicated. 

The proposals address these complications through various consolidations, both of the loan programs and of the repayment options. For the loan options, policymakers focus on having one undergraduate loan option and consolidate income-driven repayment plans. These repayment plans base the monthly loan payments on a borrower’s income, rather than spread out evenly over a set amount of time. Some proposals would make income-driven the automatic option, while others simple consolidate the various forms that currently exist but keep other standard plans untouched.

In order to consolidate into one undergraduate loan program, policymakers (Sens Alexander and Bennet), and Sens Warner and Rubio, among others) consolidate into one unsubsidized Stafford loan. This means that the need-based subsidized loan, where the federal government pays the interest while students are still enrolled, would no longer exist. The elimination of this loan option could cost students significant money. For a student who takes on the full amount of subsidized Stafford loans ($19,000) and graduates in four years, this is $2,187 (assuming a 4.66% interest rate all four years). But many students take six years to graduate, and therefore could accumulate up to $30,000 in subsidized Stafford loans. In this case, they $5,051 by not having the interest capitalize on their loans during college. (TICAS has a great loan primer and FinAid.org has several calculators, including one for interest capitalization.) 

To address the many, complex, options for loan repayments Senator Harkin (D-IA and chair of the Senate HELP Committee) recommends combining all of the income-driven options into one choice. Senators Alexander (R-TN and ranking HELP Committee member) and Bennet (D-C) go farther, limiting to two options: one standard repayment plan and one income-driven plan. Senators Warner and Rubio go the furthest proposing an automatic repayment plan based on income and paid through paycheck withholding. The arguments for using income-driven repayment options are well documented. In this report, which NCAN provided feedback on during its creation, documents how it is most likely low loan total borrowers who default and how defaults have been rising. In particular, it argues for an automatic income-driven plan that every student is placed into because students who drop out of college, and therefore do not complete exit loan counseling, are likely to default. 

Research shows that whether or not a student receives subsidized or unsubsidized loans does not change his/her likelihood of attending college. But is the complication, which means behavior incentives aren’t working, enough of a reason to eliminate a benefit that saves students money? For a low-income student, is the promise of an income-driven repayment plan worth a minimum of $2,000 and a possible $5,000 in extra interest? 

The FAST Act from Senators Alexander (R-TN) and Bennet (D-CO) takes the money saved from the subsidized Stafford loan program and redirects it into the Pell Grant program. This could possibly make the subsidized loan sacrifice worth it.  Senator Harkin does not change the loan programs on the front end. However, the proposal from Sens. Warner and Rubio , as well as others floated around the Hill and from think tanks, would eliminate the subsidized Stafford. These latter proposals, however, do not address where the savings would go. These proposals are based on the following theory: that it is better for the safety net to come after college, during the repayment phase and be based on a borrower’s earnings after the education, than to be based on their circumstance prior to enrollment.  

The answer may be that it depends on where the student attends college. One NCAN member points out that a low-income student who attends a low-cost institution may only receive unsubsidized loans after the Pell Grant and state grant because they do not have remaining need. However, a higher income student at a high-cost institution could qualify for the subsidized loan. For both students, in the worst case scenario that they can’t repay, the income driven plan would protect them. But in the best case scenario that they significantly increase their income, they would end up paying more interest for their student loans. 

As these changes are debated in Congress, everyone must ask themselves if abandoning the subsidized Stafford loan program is necessary to expand income-based repayment. And if it is, or if better targeting the dollars to those who need them most is preferred, should those dollars be directed to the Pell Grant program, loan forgiveness, or the deficit? This advocate’s vote: yes, maybe, and not until college is affordable for low income students.

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