This post addresses some general issues on Income Driven Repayment (IDR) loan payments and some specific issues raised by the new Save on a Valuable Education (SAVE) program.
Note the courts have temporarily blocked the SAVE program but several IDR programs still exist.
What determines whether a student borrower should choose an IDR or traditional student loan?
An IDR loan is the most viable way to prevent default for many people leaving college with substantial student debt and a relatively modest starting salary. However, many people who initially enroll in an IDR program because it is the only viable option will end up paying substantially more over the lifetime of the loan than under a standard student loan contract.
A student borrower leaving college with $25,000 in student debt at a 5.0 percent interest rate would pay $3,182 per year on their student loan. Total loan payments on an IDR loan that charges 10 percent of disposable income would come to $1,813.
The payment differential between the conventional and IDR loan will change with changes in income and marital status.
Increases in salary increase IDR loan payments, which can cause the borrower to shift to a conventional loan. The decision to convert the IDR loan to a conventional loan ends the possibility of a partial loan discharge. (It would usually be very foolish for a person to turn down a nice raise at work to remain eligible for a loan discharge.)
Increases in household income after marriage will often increase IDR payments and can induce the borrower to shift from IDR loans to conventional loans. A married IDR borrower can reduce the increase in the student debt payment by filing a separate return but a decision to file separate returns will often result in a substantial increase in tax obligations which, as discussed below, often offsets any savings on student loan payments.
What are the costs associated with married couples filing separate returns to take advantage of lower payments from IDR loans?
A married couple where one or both spouses have an IDR loan could reduce their combined student loan payments by choosing filing status married filing separately, but it is highly likely this choice will substantially increase their tax obligations.
Articles on whether a married couple should file a joint return, or a separate return generally focus steps a taxpayer must take to insulate themselves from their spouse’s tax liability and the loss of tax deductions and credits.
The largest impact of the decision to choose the file married separately returns often stems from a shift in tax deductions towards the spouse with lower income.
A married couple making $120,000 filing a joint return taking the standard deduction of $27,700 will pay federal tax of $10,921. The same married couple filing separate returns where one spouse makes $40,000 and the other spouse makes $80,000 where each spouse takes the standard deduction of $13,950 will pay a combined household tax of $12,787.
There are several restrictions on taxpayers who choose to file separate returns to take advantage of an IDR loan program, which will further increase the cost of choosing filing status married and separate returns over filing status married filing a joint return.
· When one spouse in a household filing separate returns chooses to itemize deductions the other spouse must also itemize deductions.
· Households filing separate returns cannot deduct interest on student loans.
· The income limits on contributions to both a Roth IRA and a conventional IRA when either the worker or spouse have access to a 401(k) is $10,000. Relatively few taxpayers who file separate returns will be able to utilize an IRA if either the worker or the spouse have access to a 401(k) plan.
· Married couples filing separate returns are ineligible for spousal IRAs.
· People filing married/separate returns cannot claim the childcare tax, the American Opportunity Tax Credit, or the Lifetime Learning Credit.
Many newly married student borrowers will immediately switch from an IDR loan to a conventional because either the IDR loan is unaffordable, or taxes would increase substantially from a change in filing status in a futile effort to maintain the IDR loan.
The switch from an IDR loan to a conventional loan will result in the loss of a future student loan discharge.
What is the potential impact of divorce on successfully paying off a student loan under IDR programs.
IDR relief may not be available for a person who switches from an IDR plan to a conventional plan upon marriage and then gets divorced and wants to reenter an IDR program. A current Biden Administration effort to update and modify IDR loan records, described below, includes a provision that allows for payment credits on IDR loans for payments made under multiple plans. But this one-time fix may not be available under future administrations.
Changes in student loan payment obligations caused by changes in income or marital status make the IDR option an uncertain path to obtaining debt relief. A more effective approach would involve partial discharge after several on-time payments earlier in the life of the loan.
Why are so few people getting IDR loans discharged?
Even after accounting for conversions from IDR to conventional loan programs due to changes in income and marital status relatively few student borrowers are obtaining timely debt discharges from IDR loans. A GAO report found that as of June 1, 2021, only 157 IDR loans had been approved for forgiveness even though another 7,700 loans were potentially eligible for forgiveness.
Both borrower and loan servicer errors result in inaccurate reporting of student loan payments and annual recertifications as documented in this CFPB report. One reason why it is difficult to track payment errors is that in some years or months the required payment on the IDR loan is zero, an amount that is indistinguishable from the amount received if the person failed to make a payment on time.
A failure to annually recertify income and household size can result in loss of IDR payment status. This document indicates that applicants under the SAVE program who fail to recertify will be ineligible for a loan discharge while applicants on the PAYE, IBR or ICR plan can remain in the IDR plans, but their payment will be based on the 10-year standard repayment plan.
What can be done to increase on-time IDR discharges? What are the limits of efforts to improve the administration of IDR loan programs?
There have been several attempts to facilitate IDR discharges by reviewing, modifying, and updating student loan payment records. Congress passed legislation in 2019 to help facilitate IDR loan discharges. The Biden Administration announced an IDR review effort in April 2022. The current Biden Administration effort to update and modify IDR loan records adjusts payment counts for forbearances, deferments and payments made under other payment plans.
The Biden Administration has been aggressive about helping IDR loan applicants obtain a loan discharge. Future Administrations may not place a high priority on facilitating student loan discharges, hence IDR loans unlike other loans and relief options are impacted by a form of political risk.
Despite these ad-hoc payment count adjustment efforts the number of IDR discharges remains low, and many discharges occur later than stipulated under the contract.
A better solution to facilitate debt relief is to provide partial debt discharges earlier in the life of the loan after several on-time payments. There are several advantages of this approach:
· Earlier detection of processing errors will assure more people get some debt relief.
· Partial rather than total debt relief will assure that an increase in the amount of student debt people take out will increase the amount repaid.
· A student loan with a partial debt-relief provision embedded in the actual contract will be honored by all Administrations, while changes to IDR loan programs enacted by executive actions occur at the whim of the current administration.
What are the major changes to the IDR program under the Biden Administration’s SAVE program?
The major changes announced under the SAVE program listed here include:
Increase protected income for loan payments from 150 percent of the federal poverty line (FPL) to 225 percent FPL.
No interest charge when the IDR payment is lower than interest due.
Allows married borrowers to exclude spouse’s income when filing separately.
Disallows existence of spouse in household size calculation when filing married separately.
Payment rate on SAVE loans cut from 10 percent to 5 percent of disposable income, starting in 2024.
Links number of years needed to obtain a loan discharge to initial size of the loan balance. Students with loan balances below $12,000 are eligible for a loan discharge at 10 years. Each additional amount borrowed of $1,000 results in one additional year for eligibility of a discharge up to 20 or 25 years.
Does the SAVE program prevent loan balances from increasing overtime?
The SAVE feature prohibiting interest charges when the SAVE payment is less than the interest charge will prevent an increase in the student loan payment when the borrower makes payments on time. However, student loan balances could increase if the borrower fails to make payments or if the borrower pauses student loan payments to go back to school.
Does the SAVE program create an incentive for people with less than $12,000 in debt from going back to school and pursing more education.
The SAVE rules appear to create a disincentive for more education by recipients of a two-year degree with less than $12,000 in student debt.
The person with up to $12,000 in debt who chooses to stop further education will have the remaining balance on the initial $12,000 in debt forgiven after 10 years, if the person makes the payment on the SAVE loan.
The person who goes back to school and formally pauses student debt payments will likely have around $30,000 in total debt upon completion of a bachelor’s degree and no chance for a loan discharge for another 20 years.
It may be possible for a student to maintain payments on the original IDR loan while in school and get a partial discharge of debt after 10 years. Department of Education rules on this point appear ambiguous.
A temporary loan consolidation program, currently offered by the Biden Administration, would shorten the potential repayment period by starting the clock towards repayment on the date of repayment of the oldest loan. This current temporary program may not be offered by future Administrations.
How does the SAVE option impact student debt payments for a typical BA degree recipient?
The typical bachelor’s degree recipient will end school with around $30,000 in student loans and start her career at a relatively low salary. The initial payment on the loan, currently 10 percent of adjusted gross income over 225 percent of the federal poverty line, is relatively small and is unlikely to reduce the loan balance for many borrowers.
A low-income SAVE loan borrower essentially has a zero-interest loan with an unchanged $30,000 balance until the borrower’s salary rises to the point that her payment (defined as 10 percent of the difference between AGI and 225 percent of the FPL) falls below interest charges.
A person who maintains a low-salary and low household income will make modest student loan payments for twenty five years and have the loan forgiven assuming the loan payments were correctly reported by the loan servicer.
A student borrower who obtains a higher salary or household income would have to make higher loan payments. The higher loan payments could reduce the number of years it takes for the borrower to repay the loan.
The SAVE loan does not limit the monthly payment on the loan when AGI rises. Other programs like PAYE and IBR cap the monthly payment at the payment for a 10-year standard loan, but these programs would allow the loan balance to increase if the loan payment did not cover interest costs.
Dave Ramsey has noted that many IDR borrowers could pay more on their student loan than the borrower with a standard 10-year loan both because payments could persist for 20 to 25 years and could rise substantially with income.
Is debt forgiven under IDR programs taxable?
The American Rescue Plan exempted dischargeable student debt from federal tax for debt discharged prior to December 2025. However, some states treat dischargeable student loans as taxable income.
Authors Note: A newly published SSRN paper examines the impact of both additional education and additional student debt on the ability of households to make a $400 emergency payment.