The federal government faces a monumental challenge this fall: after three years of suspended payments on federal student loans, the Department of Education must transition tens of millions of borrowers back into repayment. It will not go smoothly. Borrowers are likely to be confused about whether they must make payments or not, given the repeated extensions of the pause. Several student loan servicers have dropped out of the system, and others are cutting call-center hours.
At the very least, borrowers will need extra encouragement to take affirmative steps such as selecting a repayment plan and making their payments on time every month. That’s where a new proposal from Representatives Burgess Owens (R-UT), Lisa McClain (R-MI), and Virginia Foxx (R-NC) comes in.
What’s in the Republican plan to initiate repayment
The Federal Assistance to Initiate Repayment (FAIR) Act aims to attack this problem on three fronts. First, simplify and streamline the array of loan repayment plans. Second, prevent runaway accumulation of interest on federal student loans. Third, provide a stronger financial incentive for borrowers to pay down their debts.
Streamline repayment plans. Currently, federal student loan borrowers can select from a confusing array of repayment options. The FAIR Act pares those options down to two: a standard ten-year “mortgage-style” plan and a single income-driven repayment (IDR) plan. The IDR plan requires borrowers to pay 10% of their income above 150% of the federal poverty level ($21,870 for a single person in 2023).
The new IDR plan preserves elements of the current income-driven repayment system but reverses the Biden administration’s proposed changes, which would have slashed student loan payments to a fraction of their current level. The Biden plan would cut payments so much that the student loan system would effectively become an untargeted grant program, at a ten-year cost of $276 billion.
Prevent runaway interest. Though the plan does not cut borrowers’ monthly payments relative to the status quo, it does fix one of the biggest problems with IDR today: endless negative amortization. Many borrowers’ payments under IDR are insufficient to cover interest, meaning their balances grow even as they pay their loans month after month. Even though payments are affordable, borrowers rightly feel that their debt is getting out of control.
The FAIR Act fixes this problem by capping IDR borrowers’ total payments at the amount of principal and interest that they would owe on the standard ten-year plan. Even if borrowers take longer than ten years to repay, they will only owe ten years’ worth of interest. Past a certain point, interest will stop accumulating.
Incentivize lower-income borrowers to make payments. Borrowers who earn less than 300% of the federal poverty line ($43,740 for a single person in 2023) will receive extra help paying down their loans—so long as they keep up with their payments. If a low-income borrower enrolls in an IDR plan and her payments do not cover accrued interest, any unpaid interest is forgiven. Moreover, if her monthly payments are less than twice accrued interest, half of her payment is automatically applied to principal rather than interest.
For example, consider a borrower who owes $30,000; at a 5% annual interest rate, her loan will accrue $125 in interest per month. But her scheduled monthly payment under IDR is only $100. Under the current system, her balance rises by $25 even though she is making a payment. But under the FAIR Act, only $50 of her payment is applied to interest; the remaining $75 is forgiven. The other half of her payment goes towards principal. This means she is guaranteed to pay down her balance by at least $50 every month.
Higher-income borrowers may qualify for this benefit if they agree to pay 15% of their discretionary income towards their loans rather than 10%.
The FAIR Act would transform student loan repayment
Perhaps due to the complexity of the changes to IDR, media coverage of the FAIR Act has understated just how transformational this proposal would be for student loan repayment. The bill would virtually end negative amortization, which is among IDR’s greatest woes. Three-quarters of borrowers who use IDR owe more than they initially borrowed after five years.
The Biden administration tried to fix this in its proposed changes to IDR by forgiving unpaid accrued interest every month. However, the Biden plan sets payments so low that many borrowers will never see their balances go down. By contrast, the Republican plan guarantees that lower-income borrowers (and higher-income borrowers who opt in) will see their balances drop over time, provided they make positive payments every month. This will lift a massive psychological weight from the shoulders of millions.
This new benefit comes with a price tag. The Congressional Budget Office has not yet scored the bill, but it’s likely that the FAIR Act will cancel millions of dollars in student loan interest every month. Granted, the legislation will probably recoup these costs and then some by repealing President Biden’s $276 billion IDR overhaul. But the FAIR Act still represents a substantial increase in costs relative to the pre-Biden status quo. The interest forgiveness could also reduce students’ price sensitivity somewhat, potentially giving colleges an opening to raise tuition.
Last year, House Republicans introduced a comprehensive higher education bill (the REAL Reforms Act) that included similar, but more limited, caps on interest accumulation. The REAL Reforms Act, however, also included caps on new federal lending. The larger the loan, the larger the interest, and the more expensive the interest forgiveness. Limitations on loans are necessary to keep costs down. As I wrote in my analysis of the REAL Reforms Act:
“It is critical that the new interest cap remains paired with the REAL Reforms Act’s limitations on new borrowing in order to keep costs down. Forgiving several years’ worth of interest on a $200,000 loan is far costlier than forgiving interest on a $30,000 loan. To make the scheme fiscally tenable, caps on graduate borrowing are indispensable.”
It’s important not to let the perfect be the enemy of the good—enacting the FAIR Act as is would still be a net improvement—but Republicans could significantly reduce the cost of the bill if they paired it with limits on new lending.
At the same time, Democrats should recognize that House Republicans are offering a sensible reform plan that would protect borrowers from runaway interest and help them pay down their loans. The task before the federal government this fall—transition millions of borrowers into repayment after a three-year hiatus—is unprecedented. There is no better time for a grand bargain to help borrowers make progress repaying their loans.
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