Last week, the Biden administration announced it would begin a full review of several popular federal student loan programs, including income-based repayment plans. And that could mean big changes down the road for student loan borrowers.
Income-Based Repayment Plans – known more widely as Income-Based Repayment (IDR) – are federal student loan repayment plans that allow borrowers to have affordable monthly payments, even for large loan balances. The plans use a formula applied to a borrower’s income (usually their adjusted gross income as shown on their federal income tax return), adjusted for family size. Payments are recalculated every 12 months. If there is a balance left after 20 or 25 years, depending on the specific plan, that balance is canceled. This type of student loan forgiveness could be treated as taxable income for the borrower under current law, although Congress has temporarily exempted the student loan forgiveness from federal tax until 2025.
The Biden administration’s review of income-driven reimbursement programs will be conducted through a process called negotiated rule making, which involves a review and possible rewrite of federal regulations. The process begins with a series of public hearings, followed by rule-writing cycles and public comment periods.
Unlike bills, which must be approved by Congress to enact new statutory programs, federal regulations are rules issued by federal agencies under existing law. Federal agencies can use negotiated rule making to modify or even substantially modify or add to existing federal programs without having to involve Congress at all. The negotiated rule-making process was used by the Obama administration to create two brand new income-driven reimbursement plans without any involvement from Congress: Pay As You Earn (PAYE), which was created in 2012, and Revised Pay As You Earn (REPAYE) in 2015. These programs have resulted in a substantial reduction in monthly payments for millions of student loan borrowers. The PAYE and REPAYE regulations were drafted under the umbrella of an old income-based repayment plan called Income-Contingent Repayment (ICR).
It’s entirely possible that the upcoming negotiated rule-making sessions announced by the Biden administration could similarly be used to improve existing income-based repayment plans, or perhaps even replace those plans with a higher plane. While it’s far too early to know what a new income-based repayment plan might look like, Biden proposed a new income-based repayment plan during his presidential campaign last year. The main feature of his proposal was a dramatic reduction in monthly payments. Currently, all existing income-oriented schemes use a formula applied to a borrower’s “discretionary income” – the amount of their gross income adjusted above a poverty-exempt limit. The formulas range from 10 to 20% of the borrower’s discretionary income, depending on the plan. Biden had proposed a new plan that would require borrowers to pay only 5% of their discretionary income. If passed, that would equate to a 50% reduction in payments compared to the PAYE and REPAYE plans, currently the most affordable income-based repayment plans.
Other possible reforms to income-based reimbursement programs are sure to emerge during the development of negotiated rules, such as the following:
- Shorter repayment period – Most student loan borrowers have to pay off their loans for 25 years before they can get their balances forgiven. But some borrowers, such as those eligible for the PAYE plan, and borrowers who are paying their REPAYMENT loans who do not have graduate loans, may get loan forgiveness in 20 years.
- Consideration of expenses – Biden’s plan in his 2020 campaign would have allowed student loan borrowers to factor in household expenses. Currently, income-oriented plans do not take into account the borrower’s expenses.
- Taxation on loan forgiveness – Currently, canceling a student loan under income-based repayment plans can be a taxable event for borrowers, resulting in a “tax bomb” at the end of the term. repayment of the borrower. Congress recently exempted the cancellation of federal student loans from tax by inserting a provision in Biden’s recent stimulus bill, but that exemption is temporary and expires at the end of 2025.
- Accrued interest – One of the problems with current income-driven repayment plans is that monthly payments may not be high enough to cover ongoing accrued interest. This can lead to dramatic increases in the balance over time, even if the borrower makes their payments on time and progresses toward a possible loan forgiveness. This can make repayment of the loan much more expensive, if not inaccessible, and could also lead to an even bigger “tax bomb” at the end of the repayment term. PAYE and REPAYE, the two new income-focused plans, included interest benefits designed to mitigate the accumulation or capitalization of interest, but those benefits ultimately failed to stop the runaway growth of the balance. A new income-focused plan could potentially include more aggressive protections, such as strict caps on accrued interest.
- Parent PLUS Loans – Federal Parent PLUS Loans, which are loans to parents for their child’s undergraduate education, are largely excluded from income-based repayment plans. Parent PLUS loans that are consolidated through the Federal Direct Consolidation Program can be repaid under the Income-Based Repayment Plan (ICR), but this plan is much more expensive than other income-based options. Since the inception of PAYE and REPAYE, the struggles of Parent PLUS borrowers have gained attention, which may increase the chances that Parent PLUS borrowers will benefit from reforms to these repayment programs.
The first public hearings examining these and other federal loan programs are expected to begin later this month. But developing negotiated rules is a long process. It will be months before student loan borrowers have a clear idea of what reforms to income-based repayment programs might look like, and possibly one to two years before the new regulations are finalized.
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