More Student Borrowers Opting for Income-Driven Repayment, But Is It a Good Idea?
Posted By Derek Johnson on April 1, 2016 at 5:10 pm
When it comes to combating the worst ills of the student loan debt crisis, there may not be a more popular salve than income-driven repayment. The series of programs unveiled over the past six years (Income-based Repayment, Pay As You Go, Revised Pay As You Go and Income Contingent Repayment) are designed to reduce a student’s federal loan bill to a manageable percentage of their monthly income.
Now, new federal data by the Department of Education are giving us an idea of how these policies may be affecting borrowers’ choices and behavior. The FSA Data Center recently released its quarterly report, encompassing all relevant loan repayment statistics for 2015. Compared to previous years, the rate of borrowers requesting to defer – or delay – their monthly loan payments due to economic hardship has gone down drastically.
In 2015, just 370,000 borrowers from the Direct Loan program (which comprises 70 percent of all existing student loans) asked the government for more time to pay their bills, a 31 percent decrease from 2014. The remaining 30 percent of loans, handled through the Federal Family Education Loan program, saw a similar drop of 35 percent. Delinquent payments have also seen a dip of more than 11 percent for Direct Loan borrowers and 6.3 percent among all student loan debtors overall.
Enrollment in income-driven repayment plans is up
At the same time, the number of borrowers opting to utilize income-driven repayment has shot up sharply over the past two years. Since 2013, enrollment in three of the four repayment programs (REPAYE began in December 2015) has risen by 140 percent among Direct Loan borrowers alone.
In short, more student debtors are opting to use income-driven repayment, and the Department of Education believes this is reducing the number of borrowers facing delinquency or default. That’s largely a good thing and provides evidence that the programs are reaching the department’s target demographic: recent graduates without high-paying jobs who currently lack the spare income to pay their monthly loan bills. In 2014, the Department of Education announced an outreach and educational initiative for the estimated 2.5 million “borrowers who have left college without completing their education, missed their first loan payment, and those who have defaulted on low balances loans to get them back on track with their loan payments.”
Short-term gain, long-term cost
In the short term, capping a borrower’s loan bills to 10 or 15 percent of their monthly income can provide financial relief and increased breathing room while young graduates search for higher paying jobs. But using income-driven repayment over the lifetime of your loan can actually wind up costing students significantly more money. By paying less, a borrower is leaving a higher principal to charge interest on. Student loan interest rates are fairly high (6.8 percent in many cases) and so the longer it takes to pay off a loan, the more you wind up owing overall.
Making things worse, most student loan providers will prioritize paying off the interest on your loan before applying whatever is left to the principal. Anyone who has spent a year or more paying off their student loans only to watch their overall debt totals barely move is familiar with this dynamic. As debt expert Steve Rhodes put it on his blog:
“Mathematically, the least expensive way to eliminate a federal student loan is to make the full 10-year standardized payment. This will maintain the current interest rate of the loan, which can be very low, and eliminate the debt in the shortest payment period.”
Though you typically won’t find it in their celebratory press releases, even the Department of Education acknowledges this reality. From the Office of Federal Student Aid:
“Income-driven repayment plans usually lower your federal student loan payments. However, whenever you make lower payments or extend your repayment period, you will likely pay more in interest over time—sometimes significantly more.”
Most borrowers won’t make up the difference once they start earning higher salaries either. In most cases, once your income rises to the point where the income-driven repayment rate surpasses what you would pay with the standard monthly rate, your obligation automatically defaults to whichever number is lower. So while enrolling in these programs provide some relief in the short-term, most who use it are committing themselves to higher overall debt totals and a longer repayment period.
None of this addresses the opportunity cost of paying student loan bills well into your thirties and forties. The ability to buy a home, invest, start a business or save for your child’s future college costs can be negatively impacted by stretching out your student debt obligations. This has caused The New York Federal Reserve to lament that “[w]hile highly skilled young workers have traditionally provided a vital influx of new, affluent consumers to U.S. housing and auto markets, unprecedented student debt may dampen their influence in today’s marketplace.”
Overall, income-driven repayment won’t be going away anytime soon. It remains a popular tool for managing student debt among borrowers, experts and politicians. Originally introduced and implemented by the Obama administration, the idea has gained traction in recent years as think tanks and presidential candidates on both sides of the partisan divide have incorporated various forms of income-driven repayment programs into their education plans.
As the federal data shows, this collective push is influencing how Americans view their long-term debt obligations, but it will be some time before the full effects (both positive and negative) are realized. One statistical trend that hasn’t reversed or slowed over the past few years in total student debt, which rose from $1.09 trillion in 2013 to $1.35 trillion last year.