Biden has another student loan forgiveness plan

By turning all the dials to 11 on a decades-old loan repayment regulation, Biden has quietly resurrected his free community college initiative. And more: He has created an enormous, permanent new source of college funding, one that could fundamentally change the economics of higher learning.

How it works

Congress created a program called income-driven repayment, or IDR, almost 30 years ago. It has two main components. First, monthly loan payments are limited to a percentage of the borrower’s disposable income, defined as their total income minus the cost of living, instead of a standard plan that requires a predetermined monthly payment. If their total income is less than the cost of living, they don’t have to make a payment at all, and their loan doesn’t go into default, which helps financially struggling borrowers.

But this first component created a problem. Presumably, people would choose IDR only if the monthly payment was less than they owe under the standard plan, where you make the same monthly payment for 10 years and then the loan is fully repaid, like a mortgage. But when the payment is lowered under the IDR plan, the loan still accumulates interest, which then gets added to the original balance. If payments are lower than the interest that accrues, people in IDR see their balances go up, a process called “negative amortization.”

The solution was in the second component of IDR: loan forgiveness. After borrowers made payments under IDR for a certain amount of time, the Department of Education would forgive any remaining balance.

The response was … crickets. Only a small fraction of borrowers signed up.

The problem came down to three key numbers: the cost of living, the percentage of disposable income (that is, total income minus the cost of living) borrowers owe each month and how many years of payments trigger loan forgiveness. Congress left it up to the Education Department to set those values. It decided on the federal poverty line, 20 percent of income and 25 years of payments, respectively.

In the end, the point of IDR is to lower monthly payments. However, in the long term, borrowers often ended up paying more and living with debt longer (as seen in the chart below).

Under those parameters, IDR was stingy — many people with low incomes didn’t benefit. For other borrowers, spreading out payments over 25 years meant paying more on their loan, even with some of the balance forgiven. The IDR plan was a disappointment, and another decade went by, during which colleges relentlessly increased prices and loan balances ballooned.

Take two

In 2007, Congress rolled up its sleeves and decided that the best course was the same plan, but with more generous parameters, including cutting the forgiveness period to 10 years for people in public service jobs. Then Barack Obama was elected and proposed making the parameters more generous still. Congress agreed, and the Obama administration used its discretion to set loan forgiveness parameters under the 1993 law to speed up the implementation, increasing the cost of living and cutting the percentage of disposable monthly income owed. It also reduced the number of years before loan forgiveness was triggered.

This still didn’t do much for community college students, who tend to not borrow much because community colleges are generally pretty affordable and their degrees shouldn’t, in theory, take long to complete.

It was, however, a boon for graduate students, who tend to borrow much larger amounts than undergraduates. After 2008, the largest generation of college students in American history looked out into the burning wasteland of the Great Recession labor market and said, “Uh, no thanks, I’ll stay here for a while.” From 2014 to 2020, as the number of graduate students swelled, IDR enrollment more than quadrupled, from 1.9 million to 8 million borrowers, representing over $500 billion in debt.

But all those big loans and low monthly payments meant an explosion of accumulated interest and negative amortization. This problem was supposed to be solved by loan forgiveness. But when all the promised forgiveness timelines started to converge during the Trump Administration in 2018 — 25 years since the original IDR and 10 years for public servants under the newer IDR — the result was an enormous bureaucratic train wreck.

Hundreds of thousands of people applied for loan forgiveness, and more than 99 percent of them were rejected, for a variety of reasons — Congress had made the process far too complicated, the private firms that the Education Department contracts with to service the loans did a bad job, and people didn’t understand that “10 years” actually meant “120 months in which you were employed full time in a qualifying job and made payments on your loans.”

This radicalized the already-pretty-radical student loan forgiveness movement. To them, IDR wasn’t just a failure — it was a trap. Without loan forgiveness, negative amortization meant people would be in debt forever. As soon as Biden was elected, they began pressuring the administration to stop trying to make debt bondage more palatable and instead just wipe it out. Pressure grew after free community college failed, and in August, Biden finally came through.

The Biden administration and IDR 3.0

The parameters for the latest, greatest IDR are still being finalized by the Department of Education, but the top-line numbers take the Obama-era changes even further, again increasing the cost of living, slashing the percentage of monthly income owed for undergraduates, and cutting the number of years before loan forgiveness in half — but only for people who borrow less than $12,000. Importantly, the Biden plan also lists a fourth change: eliminating negative amortization.

The Biden administration has taken the benefit parameters of IDR and dropped them squarely onto the fat middle of the community college student income curve. Safety net for the unfortunate few has become subsidy for the everyday many, and the number of people who could benefit is enormous. There are currently 6.3 million students enrolled in community college, and many multiples of that who will be enrolled in coming decades. For 96 percent of them, two years of tuition is less than $12,000 — and that’s before applying Pell Grants and G.I. Bill scholarships, at least one of which nearly half of community college students receive.

In low-tuition states like California, the Biden IDR plan will be much more generous than the doomed Biden free community college plan. $12,000 won’t just cover tuition but also offset the cost of books and room and board. The Biden plan also has the advantage of progressivity — it wouldn’t subsidize tuition for the relatively small number of community college graduates who earn large sums of money after graduation.

By taking advantage of 1990s regulatory authority to make IDR far more generous than Congress originally envisioned, Biden has developed a free community college plan at a long-term cost to the Treasury of hundreds of billions of dollars. The question now is what happens once students, colleges and Biden’s political opponents realize what he’s done.

What’s next

To put $20 billion a year in perspective, it’s about twice the current cost of the G.I. Bill and two-thirds the cost of the Pell Grant program, which serves nearly 7 million people. It is arguably the biggest new college aid program in half a century and immune from the whims of the annual congressional budget process.

The amount is so large because the new IDR doesn’t apply only to community college students. In fact, most of the benefits will likely go elsewhere. All undergraduates may qualify for the reduced 5 percent payment, and people with bachelor’s degrees who borrow typically leave school with nearly $30,000 in debt. Graduate students, who make up a vastly disproportionate share of borrowers with high loan balances who are currently enrolled in IDR, could benefit from the higher cost of living allowance and the elimination of negative amortization.

There will be challenges in getting students to sign up. The best way to make community college free is to not charge tuition up front. That’s why Biden tried that approach first. Creating free college through the student loan apparatus involves pumping tens of billions of dollars backward into the system, from the wrong end, rendering tuition free retroactively, but only after requiring students to successfully perform a pantomime of indebtedness for 10 years without missing a step.

There’s also the issue of whether $20 billion in new subsidies might induce colleges and universities to raise their prices. There is a contested literature on this question in terms of college subsidies and prices in general, in part because college markets are complicated — people usually decide whether and where to go to college and how to pay for it, then complete their studies with a diploma (or drop out), and then figure out how to pay back their loans. The loan repayment scheme isn’t usually part of the initial decision. The new IDR is, in some ways, a grand experiment to see just how many billions of federal dollars are enough to change that.

The new IDR was created in response to a political movement that defined student debt as a terrible burden that must be expunged by any means necessary. If the Biden administration plan for mass debt forgiveness is struck down by a conservative Supreme Court, the principal legacy of that response may be a program that induces millions of new students to take out loans they would have otherwise forgone. That puts the burden on colleges, students and the Department of Education to make sure this bold but risky plan actually works.