Implications of student debt provisions in the July 4, 2025, Tax Bill
Ten comments on Trump’s approach to student debt
Key Findings:
· Trump and previous student loan systems both force people to “choose” the affordable IDR option
· Lifetime payments of all IDR options and the likelihood of a timely discharge remain uncertain
· Future student loan discharges are likely to be subject to federal income tax
· Loans under Trump’s RAP program will not negatively amortize, a major plus compared to IBR loans
· RAP borrowers must make 30 years of payments to become eligible for discharge, much larger than IBR programs
· An increase in interest rates could substantially increase costs of RAP program to taxpayers
· Married couples filing separate returns could substantially lower monthly RAP student debt payments but will likely pay more in tax and make many more payments
· RAP programs can end in unfair outcomes for marriages ending in divorce
· Several features of Trump student debt plan increase costs for doctors thereby impacting cost and quality of health care
· Application of tiered percentage to entire AGI leads to abrupt large increases in student debt payments for RAP borrowers entering a higher payment tier
· RAP borrowers can lower student debt payments by choosing conventional 401(k) plan and health savings accounts over Roth and other traditional insurance arrangement, but this decision can increase lifetime loan costs and may not be optimal investment choice
· The Trump reforms will lead to an increase in the number of student borrowers unable to repay their loan prior to retirement
Introduction: Trump’s tax bill enacted on July 4, 2025, has substantial implications for student borrowers. This memo describes some of the changes in the bill and potential implications of the bill for student borrowers and taxpayers.
Description of Trump-era student loan provisions:
The major changes in the recently enacted tax law impacting student borrowers involve the creation of a new Income Driven Replacement (IDR) Loan program called the Repayment Assistance Plan (RAP) and the phasing out of previous IDR loan programs.
· After July 1, 2026, new student loan borrowers will only have two options, the RAP plan or a conventional student loan plan with a maturity ranging from 10 to 25 years.
· Existing borrowers have access to a modified IBR program until July 1, 2028.
· The minimum RAP payment is $10 per month for all borrowers.
· The payments is a tiered percent of income – 1 percent for 10,000 to $19,999, … 10 percent for those over $100,000.
· Changes in tier percentages are applied to total AGI, not just the incremental difference between tiers.
· Borrowers with qualifying dependent can subtract $50 per month per dependent subject to the $10 per month minimum payment.
· Unpaid interest is waived preventing negative amortization.
· There is a guaranteed $50 per month decrease in loan balance per month even for low-income people when the loan payment does not cover the entire interest bill. The guaranteed monthly payment will be as high as $100 for low-income households when both spouses have student debt.
· Loan balances will be forgiven after 30 years of qualifying payments. (RAP borrowers in the PSLF program can still get PSLF loans forgiven in 10 years.)
The Trump Administration implemented several other changes to student loans, which will have a substantial impact on both student borrowers and taxpayers.
· New loan limits for graduate students, professional students, and parent plus loans.
· Creation of an aggregate borrowing cap,
· Restrictions on parent plus loans and elimination of Grad Plus loans for new borrowers
· Blocking borrower defenses for students at schools that close
· Resumption of interest payments and collection efforts on student debt
· Elimination of some deferments and forbearances and stricter terms on remaining deferments and forbearances.
Comments on the new student debt policies
Comment One: The major problem with any system mandating choice between IDR loan and conventional loan when student borrowers begin their career is that a shorter maturity conventional loan is unaffordable. Often the only affordable options is the IDR option.
The lack of an affordable conventional loan option can be an especially severe problem for a person who graduates when the job market for new graduates is weak, as is currently the case.
The new law makes RAP the only IDR option for new borrowers. I used CHAT GPT to calculate the student loan payments for two student borrowers faced with a choice between a conventional loan and a RAP loan.
· A student borrower with a $35,000 in undergraduate Federal Direct student loan would pay $395 for a 10-year loan, $263 for a 20-year loan, $240 for a 25-year loan and $250 for the RAP loan.
· A student borrower with $35,000 in undergraduate debt and $50,000 of debt incurred in graduate school would makes student loan payments of $1,000 per month on a 10-year loan, $674 on a 20-year loan, $618 per month on a 25-year loan and $567 on a RAP loan.
Key assumptions
· 6.38 percent interest rate on undergraduate debt,
· 7.94 percent interest rate on debt incurred in graduate school
· Starting salary of $60,000 for person with only undergraduate debt.
· Starting salary of $85,000 for person with both undergraduate and grad school debt
Many students will choose any available IDR option if it is the most affordable or the only affordable option when loan repayment begins.
Comment Two: A number of factors create uncertainty for IDR borrowers under both RAP and IBR programs. The ultimate cost of the loan is impacted by whether a discharge is granted as soon as payments are made. Loan services often fail to correctly report all payments and borrowers skip payments preventing timely discharge. (A $10 monthly minimum payment may make it easier to count all payments because it is hard to discern whether a $0 payment reflects a missed payment or is the actual amount due to reported income.)
The current congress will not renew the tax provision which exempts student loan discharges from federal income tax, thereby increasing costs of all IDR loans.
Comment Three: The replacement of all existing IDR loans with the RAP program has one desirable outcome for student borrowers.
The RAP program waive all unpaid interest on the student loan and the student loan balance will not increases overtime through negative amortization. By contrast, several IBR place unpaid interest in an “interest bucket” which can be added to the loan balance if the borrower chooses to refinance and leave the IBR program.
The RAP program waiver of all unpaid interest and the fact that RAP loans should never negatively amortize opens up the possibility that student borrowers who earn more over time and improve their credit might be able to refinance their RAP loan to a lower interest rate private student loan.
Comment Four: The least desirable outcome of replacing previous IDR loan programs with the RAP program from the perspective of the student borrower is the increase in the number of years before any allowable loan discharge. The RAP program does not allow any discharge until there are 360 verifiable monthly payment. Previous IDR programs allowed for potential discharges after 120 to 300 monthly payments.
Comment Five: A substantial increase in interest rates will lead to an increase in the cost of the RAP program for two reasons.
First, more student borrowers will choose RAP loans over conventional loans because the payment on the conventional loan becomes unaffordable, and the RAP loan payment is unaffected by interest rates.
Second, the number of RAP borrowers receiving a total or partial interest subsidy due to the RAP program guarantee that it cover all interest costs and reduce principal by at least $59 per month will increase.
I asked CHAT GPT to calculate the amount of income needed to waive interest and cover the $50 per month guarantee for a student borrower with an undergraduate loan at 6.34 percent and 7.34 percent.
· Answer was $56,381 for the 6.34 percent rate and $60,000 for the 7.34 percent interest rate. (The increase in interest rates forced the student borrower into the 6 percent loan payment tier.)
The official forecasts of the cost of the RAP program will be far less than actual costs if interest rates increase in the future.
Comment Six: Under RAP, like IBR, the student debt payment for married taxpayers who file separate returns does not include the AGI of the spouse. Also, the tiered percent used to calculate the yearly payment is lower.
Consider the impact of filing joint or separate returns on a married couple each with a $30,000 student loan at 6.38 percent, each making $46,000 per year.
· Joint Return: Student loan payments are $690 or $345 per person and both loans will be repaid in 117 months.
· Separate Returns: Student loan payments are $153.33 per month and do not fully cover interest.
Married couples who choose to lower their RAP payments by fling separate returns will not experience substantial reduction in their student loan balance, may pay their loans for many years and may pay substantially more on the loan over the lifetime of the loan.
A married couple who chooses to file separate rather than a joint tax bill is also likely to pay more in tax.
Comment Seven: Many marriages don’t last forever and both IDR loan programs can result in unusual and unfair outcomes. CHAT GPT helped me create a case where a doctor in residency with a lot of debt is married to a teacher with modest debt. In this scenario, the teacher’s salary is higher than the doctor’s during the residency. In this case the teacher’s debt load can rise by a greater percentage than the doctor’s debt load during the residency.
This outcome seems unfair if the marriage dissolves and each party keeps their own loan.
Comment Eight: Several features of the Trump student debt policy will substantially increase costs for doctors, impact medical costs, and the supply of doctors serving different populations,
The limit on direct lending and elimination of PLUS loans will increase the demand for private loans which often have higher interest rates. The range in interest rates on private student loans is huge with the actual rate determined by the credit profile of the applicant. Moreover, changes in forbearances and deferments will force aspiring doctors to immediately apply for RAP when entering residency to prevent growth in unsubsidized loan balances.
Comment Nine: The tiered percentages used to determine loan payments under the RAP plan apply to the entire amount of adjusted gross income, not just the incremental income leading to a large increase in student loan bills whenever increases in income force the borrower into a higher tier. The decision to apply a single tiered percentage to all of reported AGI instead of the incremental AGI differs from normal tax practice as illustrated by the formulas for federal income tax due and the premium tax credit on state exchanges.
Go to this finance post for an additional discussion of the decision to apply a single tiered percentage to all of AGI when calculating student loan payments.
Note the abrupt change in student loan payments could also result in an abrupt loss of the $50 per month subsidy for loan balances when the loan payment does not cover interest costs.
The abrupt loss of benefits from earning a bit more money can be quite demoralizing.
Comment Ten: A person with a RAP student loan can substantially reduce student loan payments by contributing to a conventional 401(k) plan instead of a Roth and by contributing to a health savings account because both types of contributions reduce AGI.
Consider student loan payments for a RAP borrower with $81,000 in gross income, a $35,000 loan at 6.34 percent interest under two assumptions – (1) 10 percent conventional 401(k) and $5,000 in health savings accounts and (2) 10 percent Roth 401(k) and $0 in health savings account.
· The person reducing AGI by making tax exempt or deductible contributions pays $340 per month on the RAP loan
· The person choosing investments that do not immediately reduce AGI will pay $540 per month on the RAP loan.
The lower RAP payments from choosing deductible or tax exempt savings options will likely result in the borrower making more payments over her lifetime and will likely increase total student loan payments.
The student borrower may have been better off by more rapidly reducing their student loan and by contributing to a Roth instead of a conventional retirement plan. Go here for a discussion.
Concluding Remark: The Trump student debt reforms will likely increase the number of people who are unable to repay their student loan prior to retirement because of the new 30-year maximum term on RAP loans. I am very troubled by this outcome because younger workers must save more for retirement due to projected changes to Social Security.
The RAP loan program by not allowing any loan to negatively amortize does have one substantive advantage over IBR loans.
Both the Trump and the Biden student debt agendas force people to select an Income Driven Replacement loan plan as soon as they enter the workforce and start repaying their student loan. My approach, by reducing initial costs on conventional student loans and allow more people to choose a shorter maturity student loan over an IDR loan, would facilitate more rapid repayment of student debt and increase household savings for retirement and other objectives.