Student Loan Safety Nets: Estimating the Costs and Benefits of Income-Based Repayment

The plight of underemployed college graduates struggling to make their student loan payments has received a great deal of media attention throughout the recent economic recession.  The primary safety net available to borrowers of federal loans facing unaffordable monthly payments is income-based repayment, in which borrowers make monthly payments based on their earnings rather than a traditional schedule of flat payments.

The importance of these programs is widely recognized.  How much these programs will cost and how the benefits will be distributed among borrowers, however, is not well understood— in large part because these costs and benefits will be realized over multiple decades.  Without this knowledge, it is difficult to know whether these programs are meeting the goal of effectively and efficiently protecting borrowers without creating significant unintended consequences.

This report seeks to fill that gap by providing some of the first detailed evidence about the predicted costs and benefits of existing income-based repayment programs.  Authors Beth Akers and Matthew Chingos develop an empirical framework for understanding the costs and benefits of these programs and use simulation methods to apply this framework to a nationally representative sample of bachelor’s degree recipients.  These methods cannot accurately estimate the overall cost of the programs, but they provide fairly robust estimates of the relative cost of different program components, and of the share of benefits received by different groups of borrowers. 

This analysis produces several noteworthy findings:

  1. The core mission of income-based repayment systems—allowing borrowers to pay off their loans over a longer period of time based on their income—accounts for only one-quarter to one-third of overall program costs. 
  2. The forgiveness of remaining debt after set periods of participation in income-based repayment generates approximately half of overall program costs.
  3. Existing programs effectively target borrowers with low incomes, with three-quarters of benefits accruing to borrowers with incomes in the lowest quartile.
  4. Bachelor’s degree recipients who attend more expensive colleges receive a disproportionate share of benefits.

These findings suggest that existing programs may be as much as four times more costly than they need to be to accomplish their core mission of protecting borrowers from unaffordable monthly payments.  Not only is loan forgiveness unnecessary for ensuring that monthly payments are affordable for borrowers, loan forgiveness creates incentives for students to borrow too much to attend college, potentially contributing to rising college prices for everyone.  This is highlighted by the finding that graduates of expensive colleges receive the largest benefits of income-based repayment.

For these reasons, Akers and Chingos recommend that policy makers revise the existing income-based repayment programs to eliminate forgiveness, or at least significantly reduce its generosity.  Likewise, policy makers should replace the Public Service Loan Forgiveness Program, in which the debts of borrowers in the public- and non-profit sectors are forgiven after 10 years, with a more efficient and equitable program for subsidizing the wages of individuals in these sectors of the economy.