An Analysis of the Republican Student Debt Plan

Replacing Current Income Driven Replacement Loans with the Repayment Assista

Abstract: The House Republican plan to replace existing Income Driven Replacement (IDR) loans with a single plan called the Repayment Assistance Plan (RAP) has some desirable features. However, typical financial simulations understate the lifetime loan payments for many student borrowers under the RAP program. Moreover, the plan and the literature about the plan do not clearly specify financial terms for married borrowers. The introduction of RAP could adversely impact many student borrowers who leave the workforce to have a baby or take care of a family member. I am not a fan of IDR loans including the RAP proposal. My preferred approach to assisting student borrowers involves interest subsidies for borrowers during the first few years of repayment paid for by the elimination of the deductibility of interest on student loans and limits on IDR loan discharges.

Introduction:

House Republicans are drafting a plan called the Student Success and Taxpayer Savings Act, which replace current Income Driven Replacement (IDR) loans with a single option, Repayment Assistance Plan (RAP), described in this AEI Article and this Forbes article.

The objective of this paper is to evaluate the Republican proposal.

Some features of the Repayment Assistance Plan:

· There is a $10 monthly minimum payment for all borrowers regardless of income.

· The monthly payment is a percent of income where the payment percentage rises every $10,000 in income. Borrowers pay 1 percent for income from $10,000 to $20,000, 2 percent from $20,000 to $30,000 up to 10 percent of income for borrowers at $100,000.

· The government waives all interest if the required payment does not cover the interest.

· Additionally, the government provides a subsidy assuring the loan balance falls by at least $50 per month.

· Borrowers with children receive a $50 reduction in interest payments per child.

· No loan discharges until 30 years of payments.

Analysis:

The use of RAP instead of existing IDR plans does not address the major problem caused by forcing student borrowers to choose between IDR and conventional loans as soon as they begin repayment when they have little information on their future income. Many borrowers will select the RAP loan over the conventional loan because it is the only affordable option at the time repayment begins.

There are two benefits to borrowers from the new RAP program.

The RAP program feature guaranteeing that loan balances will constantly decrease by at least $50 is a substantial benefit compared to existing IDR loans which can negatively amortize.

The minimum monthly payment of $10 on RAP loans may make it easier to track payments facilitating a discharge after 30 years compared to current IDR loans. Current IDR loans are often not discharged on time because of disputes between loan servicers and borrowers. It is very difficult to distinguish a $0 payment from a person who is avoiding IDR payment obligations from a $0 payment when $0 is the minimum required payment.

Despite these features many student borrowers will have to pay RAP loans for a prolonged period and will pay substantially more on the RAP loan than on current IDR loans or a conventional loan.

Some simulations understate potential RAP payments.

Simulations based on the average amount borrowed will understate repayment costs for many borrowers who borrow more than the average.

Simulations based on the amount borrowed instead of the loan balance when repayment occurs will substantially understate lifetime RAP loan repayments.

The student loan balance at the time repayment begins on unsubsidized student loans will be substantially more than the amount borrower because interest accrues even when the student borrower is in school. Student loan repayment generally starts nine months after leaving school, but accrual of interest continues in these months. Accrual of interest continues if the student borrower returns to school or receives a forbearance.

The argument that RAP loans are affordable and will not result in 30 years of payments appears to rely on a generous assumption on the steady growth of the student borrowers income. The growth rate of income used to calculate RAP payments in the AEI simulation appears to be over 8 percent per year. A 2 percent to 4 percent annual growth rate of overall compensation would be more realistic benchmark.

The income concept used to calculate IDR and RAP payments is income included in Adjusted Gross Income (AGI). AGI grows more slowly than total compensation for many workers at the beginning of their career who are increasing their contribution rates to 401(k) plans. The slow growth of income used to calculate student loan payments caused by increased 401(k) contributions will reduce the annual student loan payment and increase the number of annual payments.

Many workers have years where their income falls for some reason. Repayment scenarios where income and student loan payments increase at a constant growth rate are not the norm. The evaluation of the likely number of years of RAP payments and total lifetime RAP payments should rely on a large sample of lifetime earnings of student borrowers, not an average amount borrowed coupled with an assumption of substantial and steady income growth.

The Republicans have not published the RAP rules for married borrowers. Is the monthly payment based on total household income or income of each spouse? Does the student loan payment depend on whether the household files separate or joint returns? Is the monthly loan percentage applied to the total of all household loans or each loan separately?

I don’t have enough information to evaluate the impact of the RAP program on payment burdens of married student borrowers.

It is likely the RAP loan, like existing IDR loans, will penalize women and men who leave the workforce to care for children.

Concluding Remarks: I am not a fan of IDR loans because these loans create a situation where the amount a student borrower must repay is highly uncertain and administrative problems often prevent the borrower from obtaining the promised discharge.

My approach, outlined here, would induce student borrowers to start repayment with a conventional loan by offering a zero percent interest rate for the first few years of repayment when starting salaries are existing low and by offering partial loan discharges after two to five years of payments. The cost of the new tax breaks would be offset by the elimination of the tax deductibility of interest on student loans, and limits on IDR loan discharges.

The RAP program has some desirable features compared to existing IDR loans, but provisions of the program are not clearly spelled out for married borrowers. It appears as though, the replacement of existing IDR loans with RAP will increase borrowing costs for many student borrowers.