With summer campaign season underway, the Democrats are looking to rouse young voters by offering them a break on their student debt. At the moment, liberal favorite Elizabeth Warren is championing a bill that would let borrowers save money by refinancing their old education loans at today’s low interest rates. By funding it with a tax hike on millionaires, however, the Massachusetts senator has all but guaranteed that the legislation will die should it ever reach the Republican-controlled House.
In other words, the bill is a glorified talking point. As President Obama put it when he backed the proposal this weekend, Warren’s bill will force the GOP to decide whether it wants to “protect young people from crushing debt, or protect tax breaks for millionaires.” In the meantime, the only real action is coming from the White House, which announced on Monday a series of modest but useful executive actions to help borrowers.
There’s a bit of irony here. While Democrats are busy turning America’s student debt crisis into campaign fodder, a Republican may actually have the single best plan for fixing it. His solution lacks the populist punch of Warren’s bill. But the idea could save millions of future borrowers from financial ruin without costing taxpayers a dime—which means that, if it could get enough attention, it might also stand a small chance of becoming law.
Since 1983, Tom Petri, a low-key House GOP congressman from Wisconsin, has advocated an idea that education wonks sometimes call “universal income-based repayment.” It would completely scrap the convoluted system that former students currently rely on to repay their loans. Instead, college debt would work like just tax withholding. A borrower would simply pay a set percentage of her monthly earnings to the government, deducted straight from her paycheck.
Countries including Britain, Australia, and New Zealand already take a similar approach. And, as many education experts have agreed, bringing it stateside would likely cure some of the worst symptoms of America’s student loan binge. It would ensure that every single borrower’s payments stayed manageable and virtually eliminate the risk of delinquencies and defaults.
Think of it as the financial equivalent of putting up gutter rails in a bowling alley—it’s a foolproof plan to stop borrowers from veering into trouble.
For example, let’s say a student borrowed $26,000 for college, at an average interest rate of about 4.7 percent. On a standard 10-year plan, she would owe $272 per month, every month. It might be affordable. It might not. On an income-based plan, however, she might owe 15 percent of her disposable earnings instead. With an adjusted gross income of $25,000, her bill might come to about $94 per month; at $38,000, it would be closer to $250. And if her earnings fell below a certain threshold, she’d pay nothing at all until her income rebounded.
The Department of Education does, in fact, already offer two income-based repayment options to hard-pressed borrowers. Unfortunately, they’re underpublicized and mired in red tape, so too few former students take advantage of their protections. Petri’s plan, or something similar, would solve that issue by making income-based repayment the automatic plan for all.
To understand why it would be such a sea change to make income-based repayment the default option, we need to talk about the complicated reasons why the U.S. is facing a student debt crisis to begin with. The first cause is obvious: Students are borrowing more than ever for school. Costs have whirled out of control across higher education, while unscrupulous for-profit schools in particular have made a killing overcharging millions of working-class students for possibly worthless degrees.
But the sheer scale of the student debt crisis is more mysterious than it may look at first. Neither the amount of debt that students pack on nor the shoddy job market of the past few years can fully explain why so many Americans are falling behind on their government loans. Of those borrowers who began repaying in 2010, almost 15 percent defaulted within three years, meaning they went at least nine months without paying. Last August the Consumer Financial Protection Bureau estimated that 6.5 million borrowers total were in default on their federal education loans—roughly equal to the populations of Los Angeles and Chicago combined.
This is both depressing and a bit odd. Given that student loans generally can’t be discharged in bankruptcy, defaulting on them doesn’t make much financial sense. The government will take you to court, garnish your wages, and demolish your credit rating long before it ever lets you off the hook on your college debt.
At the same time, the feds offer plenty of options to help troubled borrowers. President George W. Bush created the first income-based repayment program back in 2007. The newest iteration, called Pay as You Earn, is especially generous: It caps monthly charges at 10 percent of discretionary income and forgives whatever loan balance is left after 20 years. The unemployed, meanwhile, can always apply for loan deferment. There is, practically speaking, no reason borrowers should be defaulting.
And yet they do, en masse. In the meantime, fewer than 2 million federal direct loan borrowers are signed up for an income-based payment plan, despite the fact that millions more obviously would benefit from enrolling.
The reason, many believe, is that too many vulnerable debtors simply have no idea what their options are. It’s probably no accident that college dropouts, according to one estimate, are more than four times more likely to default on their loans than graduates. Aside from having a tougher time landing work, they’re also much less likely to receive any sort of loan counseling when they leave campus. The same goes for for-profit-college students, who are responsible for about half of all federal loan defaults. They’re leaving school in the dark.
“I don’t really call it a debt crisis, because the ones defaulting aren’t the ones in the most amount of debt,” says Justin Draeger, president of the National Association of Student Financial Aid Administrators. “They’re most likely the ones who dropped out or stopped out of college and then ignored their student loan debt and then didn’t follow up or felt overwhelmed.”
It doesn’t help matters that the Department of Education offers a bewildering array of payment plans, and hires 11 different private loan servicers to service them. These organizations are notoriously terrible at communicating with borrowers about their various options. The entire operation is a giant malfunctioning Rube Goldberg device.
But information isn’t the only problem. Keeping up with paperwork is also a killer. I asked Deanne Loonin, a staff attorney specializing in student debt issues with the National Consumer Law Center, why so few people take advantage of programs that could save their finances. About two-thirds of her clients, many of whom are in poverty, are already in default by the time they walk in the door, she says. Even by then, at least nine months after they stopped paying their loans, most still haven’t even heard of income-based repayment. Debt collectors and loan servicers simply don’t mention it.
Those who do know about helpful payment plans often run into snags attempting to sign up for them, such as problems qualifying for loan consolidation. Worse yet, the ones who do sign up often drop out because of the confusing continuous requirements—for example, the onerous forms that borrowers must fill out to prove their income each year. For a J.D. managing her law school loans, that sort of task might seem routine. But for someone who never finished her stint at a two-year vocational school, it’s a challenge. “There’s a whole slew of operational barriers,” Loonin says.
All of this means that the government’s income-based repayment plans, in their current form, are better-designed to help savvy borrowers like graduate students than the lower-income borrowers who need them most. Law, business, and medical students have entire financial aid offices nudging them into the best possible repayment plan. A first-generation college kid who dropped out has nobody.
The White House, to its credit, clearly understands that these problems exist. Last year, for instance, President Obama directed the Department of Education to contact borrowers and find out whether they were aware of all their repayment options. It was a necessary step that happened to demonstrate just how deeply dysfunctional much of the student loan program had become. Monday, Obama’s big announcement was that he would expand Pay as You Earn to include up to 5 million borrowers with older loans. Perhaps just as importantly, the administration said it would restructure contracts so that loan servicers had more incentives to put students in the proper payment plans.
But Obama could also consider a plan like Petri’s, which strips down the whole creaky system and puts in place something simpler, more efficient, and less prone to leaving the most hapless borrowers out in the cold. It might even be one of those fabled moments of potential bipartisan accord. Petri has found a high-profile ally in Florida Sen.—and potential Republican presidential candidate—Marco Rubio, who has endorsed the idea of universal income-based repayment on the stump as well as in an op-ed with Petri. Some House Democrats, including Jared Polis of Colorado, have also co-sponsored Petri’s latest bill.
There would undoubtedly be policy differences between the president and congressional Republicans—there could be a major argument, for instance, over loan forgiveness. (The current pair of income-based repayment programs offer it after 20 or 25 years; Petri’s bill would eliminate it, but cap interest at half the principal.) Legislators would also have to agree on a raft of details, such as whether to tweak interest rates again. Right now, default rates are the main tool the government uses to assess whether schools should be eligible for federal financial aid and lending programs. With universal IBR in place, they would need to find a different measuring stick for accountability.
But broadly speaking, implementing universal income-based repayment would finally take the risk out of student debt. And as long as we’re handing out education loans virtually no-questions-asked to all comers, that seems like a goal worth making some legislative compromises for. It wouldn’t solve the rising cost of college, but it would make paying for it far, far safer. That’s worth more than a few political points, no?
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