A now more-generous Income Based Repayment (IBR) plan for federal student loans, which limits student loan payments to 10 percent of discretionary income for students who take out loans after July 1, 2014 and forgive the loans after 20 years, took effect on November 1, 2012. The Obama administration is eager to tout the program’s benefits, explaining that the policy would “reduce monthly student loan payments for more than 1.6 million responsible student borrowers.” There’s a problem, though, the new policy may not raise enough money.
Jason Delisle and Alex Holt over at the New America Foundation recently did a fun experiment with IRB. As they write:
Senator Marco Rubio (R-FL) just announced that he paid off his student loans early with the proceeds from a book deal. Paying down debt ahead of schedule is generally a prudent financial move. But if the Obama administration’s new Income-Based Repayment (IBR) plan had been in place when Senator Rubio graduated from law school, his decision to pay down debt early would have been a sucker bet.
Why? Well, that’s because if IRB had been available it really would have reduced his student loan payments. It also wouldn’t have resulted in him paying off the loans. Delisle and Holt:
We estimate that if the New IBR plan were available back in 1996 when Senator Rubio started repaying his student loans, he would have $83,482 forgiven in the year 2015. We developed that figure using Senator Rubio’s actual income information, which has been released publicly since the year 2000. We estimate the Senator’s loan balance at graduation to be $170,000 based on apress article that indicates Senator Rubio had $165,000 in student loans in the year 2001, five years after he left school.
The authors write that the Rubio situation, which is admittedly a little creative since it assumes his debt was all based on federally backed student loans (and it surely wasn’t), highlights one of the understated problems with the new IRB (earlier rules capped payments at 15 percent of income and forgave the loans after 25 years): it’s a huge financial windfall to people with high debts.
The new IRB just allows borrowers a way to manage their student loans; it doesn’t really address the high cost of student loans or, at this point, provide anyone with an incentive to bring them down.
Would there be enough $83,000 loan forgivenesses that this would become an actual budget problem for the federal government? It’s probably too early to tell. At this point, however, the change engineered by the Obama administration would seem to create some incentive for people to take out larger student loans. If you make only $30,000 the new rule caps your payments at about $200 a month. That’s true whether you owe $20,000 or you owe $200,000. So why take out less?