4 Student Loan Repayment Reform Models to Consider

April 9, 2013

With millions of Americans struggling (and many failing) to keep up with their student loan payments, perhaps it’s time that we reconsider how this debt is handled. In its most recent budget legislation, the House proposed to drastically scale back on income based repayment plans for student loan debtors. This could drive millions (and perhaps billions) of dollars of educational debt into delinquency and default. Tomorrow, President Obama will submit his 2014 budget proposal and we can only hope that he will present more economically viable alternatives for our growing student loan crisis.

While Congress and POTUS are hashing out our budget for the coming year – hopefully without slashing IBR and other affordable repayment plans for federal loans – here are four alternate student loan repayment plan proposals to consider:

#1 New America Foundation Plan

The New America Foundation is a nonpartisan public policy institute that invests in new ideas to address challenges facing our nation – such as the student loan bubble. Their recently released policy plan to revamp federal student aid would base all loan repayment on a percentage of income. Here are some important features of their plan:

— Borrowers earning less than 300% of the poverty line (for a family of three for 2013, that would equal $58,590 or less) would repay 10% of their income above 150% of the poverty line. This means someone with a family of three earning $55,000 would pay no more than $214 per month.

— Borrowers earning above 300% of the poverty line would make payments of 15% of their income. So for someone earning $65,000, this would mean $812 monthly payments.

— Student loan interest rates would be set at the 10-Year Treasury rate plus 3%. Currently, this would mean a rate of 4.9%.

— Borrowers with an initial loan balance of $40,000 or less would have any unpaid debt forgiven after 20 years and for those borrowing more than $45,000, the repayment would end at 25 years.

— For any loan amounts forgiven, there would be no income tax implications.

Pros of this plan are that lower income earners with student loan debt would have affordable payment options. Cons of the plan are that higher income earners could face monthly payments much larger than under standard payment plans. And if the Treasury rates are high, student loan interest rates would similarly soar.

#2 Australian Model

We’ve written before about Australia’s uniquely affordable student debt model. What’s intriguing about the Australian model is that below a certain income threshold, there are no student loan payments. This differs drastically from our current system where debt collectors harass those least able to pay. Here are features of their model:

— Until student loan debtors begin earning $50,000 (US equivalent), there are no payments at all.

— Once the debtor hits $50,000 in income, payments ranging between 4-8% of income begin, paid through payroll deduction.

— Interest isn’t charged on their student loans – instead, there is a set 25% of the initial loan balance charged.

— Loan balances are adjusted annually based on the rate of inflation. 

Pros of this plan are that lower income earners are exempt altogether from payments so educational debt doesn’t cripple the poverty stricken, you’ll never pay more than 8% of your income to service your debt, taking longer to pay doesn’t rack up massive interest charges and you don’t have to jump through hoops to get affordable payments. Cons are that any debtors that leave the country can escape repayment because it’s collected through the payroll system.

#3 Petri Bill (ExCEL Act)

Last year, Representative Tom Petri (R-WI) proposed legislation that would have all student loan borrowers repay 15% of their discretionary income via payroll withholding. One striking feature of this proposed legislation is that it eliminates the option of student loan forgiveness for public service. Here are the details of the legislation:

— All federal loans for a debtor would be combined into one lump with a fixed interest rate tied to the 10-year Treasury rate. Loans up to $31,000 would have 3% tacked onto the Treasury rate and higher loans would have 4.1% added.

— Debtors would repay 15% of their income above 150% of the poverty line through payroll deduction. For a family of three for 2013, that would equate to any income above $29,295. So for example, if borrower was earning $40,000, they would pay 15% of the difference ($10,705 x .15 = $1606 ) which would result in a monthly payment of $134.

— Interest accrued during repayment would not be compounded and would stop accruing once it reached 50% of the loan’s original balance.

Pros of the plans are that low income earners will have little or no payments, loans will not amass a ton of interest and borrowers won’t have to pick through plans or substantiate income. Cons are that student loan interest rates could fluctuate wildly based on the Treasury rate, deferment and forbearance would no longer be available and neither would the public service forgiveness option.

#4 Lumni Model

The Lumni model is much like other social finance options we’ve written about. In the social lending model, students pledge to pay back a set percentage of their income after graduation – usually between 4-8% for the first 10 years of your income. Details of the financing arrangement would vary by the organizing firm.

Pros are that your loan doesn’t accrue interest and if you can’t find work or end up in a low paying field, you won’t be subject to onerously high and unaffordable monthly payments. The cons are that if you are in a high earning field, your payments could be higher than they would have been if you had financed your education through a standard loan arrangement.

Final Thoughts

Robert Applebaum, an expert on loan forgiveness, offered this commentary on the New American Foundation proposal: “I like that it’s progressive, in that the higher one’s income, the greater the percentage they pay, however, I do not like that there are no upper limits on the amount of payments one must make. I’m not crazy about their approach to setting interest rates at 3 points above the Treasury rate… however, I do like their proposal to make any forgiven amount non-taxable.  I think a much better approach is H.R. 1330, introduced last month in the House by Rep. Karen Bass.”

It’s important that we continue – as a society – to rethink how to deal with this increasingly critical issue and develop some workable solution. In the meantime, if you’re juggling student loan debt, try Tuition.io’s free student loan management tool to track and optimize your debt, check out repayment plans and contact your lender.