How to make college affordable: Income-based loan repayments

Student loans have been part of postsecondary education for over fifty years. We need them to work well.

While some borrowers stagger under huge loan burdens, the vast majority have loans that are manageable, especially given the strong financial returns to college. The key problem is not the level of debt (as previous posts in this series have made clear), it is repayment. Payments are inflexible and are due too soon, when earnings are low and variable. This can lead to financial distress.

The solution: Income-contingent loans

The solution is a federally-administered, income-contingent loan system, like those in the UK and Australia. This would be more effective and more progressive at reducing distress than subsidizing interest rates.

A well-structured, income-based loan system complements efforts to reduce college prices. Why? Even if loans are small, some borrowers run into trouble: most defaults are on debts of less than $10,000. Income-based repayment provides insurance against poor outcomes in the labor market, to which low-income, first-generation students are particularly vulnerable.

What would a reformed system look like?

A reformed repayment system would have four key features (for details, see my paper for the Hamilton Project here at Brookings):

1. Loan repayments based on income. For the vast majority of borrowers, student loan repayments are unvarying. But the economic benefits of college arrive over many years. Among those with at least a bachelor’s degree, median earnings are $32,000 for those aged 28 to 30, and $48,000 for those aged 31 to 40. Repayments ought to rise and fall with earnings, like contributions to Social Security.
2. A single, simple system. In place of the bewildering array of loans and providers, the vast majority of borrowers could be served by a federally-run loan organization that offers a single repayment structure. This could be a stand-alone institution or sit within the Departments of Education or Treasury. When the program is first initiated, private loans could be bought by the Federal Government and transferred to the new organization; after that, private loans would not be eligible. A board similar to the Social Security Advisory Board would administer the loans.
3. More time to repay. The term on a student loan is typically ten years. Given the returns to college arrive over a lifetime, it would be better to allow a longer repayment period. Under our proposed system, loan repayments would cease once the loan was paid off or after 25 years, whichever came sooner. Balances remaining after twenty-five years would be forgiven, with no tax consequences.
4. Administered through the IRS. Loan repayments would be collected through the IRS, and passed through to the new organization. Borrowers could opt to pay their loans off more quickly if they chose to do so.

College remains an excellent investment for most. Problems arise when graduates face steep repayment in the years immediately after college. There is a misalignment between the timing of the benefits of a college education and the current structure of loan payments. Repayment reform would go a long way to easing struggles of student borrowers.

Up next: Melinda Lewis on asset-based financial aid.