Balancing Risk and Responsibility: Reforming Student Loan Repayment

By Betsy Prueter

A recent report from the American Enterprise Institute (AEI) examines income driven repayment (IDR), the federal program designed to protect student loan borrowers from default by adjusting their monthly loan payment based on their income. The report agrees that IDR is a good option to help borrowers avoid default, but lays out reforms to lower defaults even further (one quarter of federal student loan borrowers default over the life of their loan). The reports also offers ideas for streamlining the complexity of the loan system as a whole.

Among the suggestions for improvement:

  • Make the loan forgiveness period contingent on the amount of money borrowed. For example, students who borrow less have their loans forgiven in a shorter amount of time. Students who borrow more have a longer period of time before their loans are forgiven.
  • Tie the percentage of income borrowers pay to how much money they borrow. So, if students pay 1% of their income for every $3,000 borrowed, a student who has borrowed $12,000 would pay 4% of his or her income. This would help address the issue that borrowers pay the same percentage of income regardless of the amount borrowed.
    • Terms could still be put into place so that at most, students who take out the maximum allowable amounts would still only pay 10 or 15 percent of their incomes.
  • Consider an alternative to the conventional interest-rate structure, such as a one-time surcharge on loans. This fixed amount would be added to the loan balance when the loan is issued. For example, if a student borrowed $1,000 with a 4% origination fee, they would start off with a balance of $1,040. This would help address the challenge of unchecked growth in interest rates pushing students into default.
  • Limit the aggregate amount of interest that can accrue on a loan. If a borrower reaches the cap, interest would stop accruing and he or she could continue to pay down the balance as a 0 percent interest loan.