RESEARCH The potential borrower impact of proposed IDR reforms

On January 11, 2023, the Department of Education proposed new rules to improve Income-Driven Repayment (IDR), a set of repayment plans that provide payment relief for people who hold large student debts relative to their income. This proposal is aimed at both improving long-term affordability of higher education and providing an avenue of relief for borrowers who may not be prepared to resume debt payments when the federal pause on student debt payments ends as scheduled later this year.

After a borrower enrolls in an IDR plan, their required monthly payments decrease to 10 percent of their disposable income (see Table 1 below), and the length of time the borrower needs to make repayment under IDR is limited. After the borrower makes enough IDR payments to reach this time limit, any remaining debt is forgiven. Borrowers whose IDR payments are less than their monthly interest accrue any unpaid interest, though accrued interest is forgiven with the remaining debt balance at the end of the payment period¹. Borrowers whose monthly payments would not be lowered by IDR are not eligible to enroll.

The proposed changes likely to have the most significant impact² leave the structure of the IDR program intact but modify its parameters in ways that lower repayment amounts. Table 1 summarizes both the parameters of the existing program and the proposed changes to those parameters. These changes decrease how much current IDR enrollees will pay going forward and increase the number of borrowers eligible.

Table 1: Summary of proposed changes

This brief leverages prior research on IDR by the JPMC Institute and others to describe the effects these rule changes will have on borrowers as well as who is likely to benefit most from these changes. We consider the proposed changes outlined in Table 1 and discuss each in turn.

1. Required payment amount for undergraduate loans will be lowered from 10 percent of discretionary income to 5 percent.

This change cuts all monthly payments for undergraduate debt in half. After accounting for the increased income deduction (see next section), all undergraduate debt payments of IDR enrollees will decrease by a little more than half. Because these payments are a fraction of income, higher-income borrowers will see larger decreases in their monthly payments. The decrease in monthly payments from these two changes is large enough that a significant fraction of current IDR enrollees will have their new payment amount be lower than their monthly interest charge. For example, a borrower with a starting balance of $29,700 and an interest rate of 4.5 percent must have an income of $57,300 or less to be eligible for IDR under current rules. Under the proposed rules, this borrower’s monthly IDR payment will be $111.34 per month, less than the monthly interest charge on their starting balance, $111.38. For a borrower with a lower balance, a lower income, or a higher interest rate, this difference will be even larger. For example, at 5 percent interest, anyone who would qualify for IDR with a balance of $37,400 or lower under the current rule will be negatively amortized under the proposed rules.

In addition to providing immediate payment relief every month, reducing monthly payments will have three general effects. First, it reduces the amount that individual borrowers pay over the life of the loan but may extend the time borrowers spend in repayment. Second, decreasing monthly payments increases the number of borrowers who are eligible for IDR. Third, it can significantly reduce the cost of taking on debt in the first place and thus could induce further borrowing. This last point has potentially complex implications for the welfare of individual borrowers and higher education financing more broadly.

Reducing monthly payments will dramatically change how much current IDR enrollees pay back over the life of their loan (Greig, Sullivan, and Ho 2022). Borrowers who are already on track to receive forgiveness will pay roughly half as much as they would under the current program structure. IDR enrollees with relatively higher incomes who were on track to pay off their loans before receiving forgiveness will also pay substantially less, with the exact amount of savings depending on the borrower’s circumstances.  As a result, these rule changes will substantially decrease the cost of debt, especially for low-income borrowers while also impacting the cost of the program to taxpayers (Dept. of Education 2023).

Making student debt cheaper may induce many students to increase their undergraduate borrowing relative to what it would be under current rules. It is hard to predict ex ante what the aggregate implications of increased borrowing would be. On the one hand, increased access and use of student loans has been shown to increase graduation rates and improve long-term income (Marx and Turner 2019; Black et al. 2023). On the other hand, there is also evidence that universities respond to more generous federal education funding by raising tuition and capturing much of the benefit of the increased funding (Gordon and Hedlund 2016; Turner 2017).

This change in monthly payments also dramatically increases IDR eligibility. For example, borrowers with a $15,000 debt are currently eligible for IDR if their incomes are less than $39,500. Under the new rules, borrowers with a $15,000 debt would be eligible with incomes up to $68,750. That is, for a given amount of debt, all newly eligible borrowers will have higher incomes than current IDR enrollees, increasing the average income of the IDR program. Moreover, it is possible that a significant majority of all borrowers will be eligible for IDR. For the maximum loan amount for dependent undergraduate borrowers, $31,000, any borrower with an income under $110,000 will be eligible for IDR under the new rules.

As a result, it is likely that a larger portion of the dollars spent through this proposed change will accrue to higher income borrowers. Borrowers with higher incomes will see larger decreases in monthly payments since the benefit increases with income³, and all borrowers who become eligible for IDR will have higher incomes than those currently eligible. However, predicting the total incidence is not immediately clear. First, newly eligible borrowers may end up paying more over the life of their IDR participation than if they had not enrolled (Greig, Sullivan, and Ho 2022). Second, if universities raise their tuition and capture some of the benefits of the rule changes, it is unclear who benefits.

2. Increased deduction from disposable income, from 150% of poverty guideline to 225%.

This change has many of the same consequences as the move from 10 percent to 5 percent of disposable income. It will lower monthly payments and thus increase IDR eligibility and decrease the cost of debt. It differs from the above change in three ways. First, this change is also available to graduate borrowers, who tend to have higher incomes. Second, the effect of this change is capped. It will save graduate borrowers no more than $91 per month and undergraduate borrowers $46 per month (as payments on undergraduate loans are 5 percent of disposable income instead of 10 percent)⁴. Third, this change also increases the number of borrowers who will pay $0 per month on IDR. For example, under the current rules, any one-person household, regardless of the size of their debt, pays $0 per month on IDR if their income is $20,385 or less. Under the proposed rules, one-person household borrowers with income up to $30,578 would pay $0 per month.

3. Shorter repayment term (10 years instead of 20) for people with undergraduate debt less than $12,000.

Low-income borrowers are relatively more likely to benefit from this change since borrowers with high debt balances tend to have higher incomes (Farrell et al. 2020). People who have trouble paying back relatively small debts tend to have very low incomes and often did not graduate. This change significantly reduces the total amount repaid by low-income IDR enrollees while having little effect on the amount paid by high-income enrollees (Greig, Sullivan, and Ho 2022).

4. Automatic recertification and auto enrollment of borrowers 75 days past due.

IDR borrowers are required to recertify their income and family size every year so that their monthly IDR amount can be updated appropriately. Automatic recertification will decrease paperwork burdens for both borrowers and the government, and does not appear to introduce any adverse incentives.

The proposed rule would also automatically enroll borrowers into IDR once they are 75 days delinquent on their payments. On one hand, this will likely help borrowers cure delinquencies, keep their credit report clean, and streamline program access to borrowers who are likely to need it. On the other, IDR is more expensive in the long-run for many borrowers (Greig, Sullivan, and Ho 2022), and past research has shown that borrowers are very sensitive to this risk (Abraham et al. 2020; Cox et al. 2020). Making enrollment automatic and permanent may lead borrowers to follow a repayment path they otherwise would have avoided. Providing explicit information about the payment plan and its consequences for long-term repayment cost could ameliorate this concern. Nevertheless, restricting automatic enrollment to borrowers who are already delinquent mitigates these concerns, since the risks of IDR enrollment may be outweighed by the risks of severe delinquency.

It is also important to note that this limited auto-enrollment may not be applicable to many low-income borrowers who are currently not enrolled in IDR but are eligible to be. Many eligible but not enrolled borrowers were current on payments and thus would not be affected by this change (Greig, Sullivan, and Ho 2020). However, the streamlining of enrollment and recertification may induce many of these currently unenrolled borrowers to finally enroll. This could provide substantial relief to these households—our data show that substantial financial help from family members and friends is allowing these borrowers to make their payments.

Conclusion

The Biden Administration has proposed several changes to the IDR program to improve college affordability in general and to provide resources for borrowers leading up to the end of the federal student debt payment pause, for which many borrowers may be unprepared (Conkling, Gibbs, and Jimenez-Read 2022). These changes significantly lower monthly payments for current IDR participants and shorten the path to forgiveness for low-balance borrowers. They would also make IDR accessible to many more borrowers who cannot enroll in IDR because their incomes are too high.

All together, these changes reduce the burden of repayment for borrowers currently in repayment, and they reduce the cost of taking on debt for current and future students. This will likely lead to increased borrowing in the future—students already borrowing may borrow more, and students who had not planned on taking on student debt may now do so. This in turn may improve student outcomes by making it easier to graduate and earn a higher income after school (Black et al. 2023). However, the sudden increase in students’ ability to pay for education may also lead universities to raise tuition and absorb the benefits of the rule change (Gordon and Hedlund 2016; Turner 2017). This could leave students as a whole worse off and drive yet more borrowing. If these changes take effect, monitoring the response of universities and state funding agencies should be a high priority for the policy community.