Last week the Obama administration took another step toward expanding their more generous version of Income-Based Repayment (IBR), known as Pay As You Earn (PAYE), to borrowers who were previously ineligible, despite growing concerns over the cost of the program and the large benefits that go to borrowers who attended graduate school. The administration plans to address those issues through changes to the formula that make it harder for some borrowers to receive loan forgiveness and by counting the income of a spouse in a two-earner family. But while rolling back some benefits, the administration has managed to create a new provision that once again skews benefits toward the people who are most able to repay their loans.
The administration wants to forgive interest on loans in PAYE every month, in addition to providing complete loan forgiveness after 20 or 25 years of payments. Specifically, unpaid, accrued interest would be “capped at 50 percent” on a monthly basis for those repaying under IBR. For example, a borrower whose monthly payment is only $50 under IBR, but whose loan accrues $100 of interest monthly, would normally have $50 in interest added to her total unpaid balance. But under the proposed PAYE rules, $25 dollars would be immediately forgiven, so that only $25 was added to her balance.
It may not be obvious at first glance, but the only people who benefit from this new provision are those who could have paid the loan back later in their repayment term, when they earned more money. Before this newly proposed benefit, under existing program rules, the borrower waits until the final loan forgiveness term to have any unpaid interest forgiven. Anyone who earned a low income throughout would have all of the money forgiven at the end. That makes forgiving interest as it accrues a regressive benefit. Most importantly, the benefit does not reduce monthly payments because payments are based solely on the borrower’s income, which is the whole point of PAYE. So the benefit does not affect the affordability of the loan.
Here is an example. With the proposed new benefit in place, a borrower earning $45,000 a year with an $80,000 loan (6% interest rate) would have about $105 forgiven every month, but if his income later increases and he fully repays his loan while using PAYE, the interest he had forgiven earlier is never repaid. It is a benefit he pockets even though he goes on to earn a higher income. If his income stays at $45,000 indefinitely, forgiving the interest earlier changes nothing for him because it would have been forgiven at the end of his loan term anyway. PAYE’s new interest forgiveness benefit doesn’t reduce his total payments unless he goes on to earn a higher income.
One reason borrowers may be fearful of enrolling in IBR is because their loan balances can grow even if they are making the required monthly payments. While loan forgiveness after 20 or 25 years of payments is supposed to address the concern, it’s too far off to sound like a real benefit and anxiety kicks in at the thought of a ballooning loan balance. That may be why the administration proposed partial interest forgiveness. But, in what has become a pattern for this administration, by trying to fix one concern regarding income-based repayment they ended up creating another windfall for those most able to repay the loans.
Likewise, those who borrow the most (i.e. graduate students) will reap the largest benefits under this new interest benefit — which is confusing given that the Obama administration successfully argued to strip graduate borrowers of a similar benefit in 2011. Graduate students do not need the in-school interest-free benefit on Subsidized Stafford loans, said the the administration, because those students have access to IBR. Now the administration seems to be saying that borrowers with graduate school debt do in fact need a similar interest benefit because they have access to IBR.
The reason why income-based repayment plans allow borrowers to accrue interest but then forgive it only after a period of time is to determine who could have paid it back and who could not. Once again the Obama administration is moving the program away from that progressive goal.
Author Bio: Jason Delisle is director of the Federal Education Budget Project at the New America Foundation.