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Income-Driven Repayment Plans for Distressed Student-Loan Debtors: Not a Silver Bullet for Easing the Student Loan Crisis

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by Richard Fossey & Robert C. Cloud.

The federal student loan program is in crisis. More than 40 million Americans now have outstanding student loans totaling almost $1.3 trillion and 8 million borrowers are in default (Cao, 2016). As reported recently by the Brookings Institution, in the for-profit college sector, default rates are especially high. Among a recent cohort of student borrowers, 47% of learners who took out student loans to attend a for-profit college defaulted within five years of beginning repayment (Looney & Yannelis, 2015).
 
Moreover, student loan debt is becoming increasingly burdensome for older Americans. As Senator Elizabeth Warren pointed out in a recent press release, over 7 million Americans over the age of 50 have outstanding student loans. The size of debt held by Americans who are 65 years and older has also grown by 385% since 2005 (Warren, 2016). A rising number of elderly student loan defaulters are seeing their Social Security checks garnished to service student debt. In fact, the number of Americans whose Social Security checks are being offset due to defaulted loans grew by 540% in just 13 years (U.S. Government Accountability Office, 2016).
 
The Obama administration has done a number of things to address this growing crisis. It has moved aggressively to better regulate the for-profit college industry, where student loan default rates are highest. It has also sought to educate students to make better decisions about borrowing money to attend college. But perhaps the Obama administration’s most important policy response to the student loan crisis has been the expansion of income-driven repayment plans (IDRs) that reduce the amount of student borrowers’ monthly loan payments while stretching out the repayment period from 10 years to 20 or even 25 years. Approximately 5.6 million Americans are currently enrolled in some form of IDR and the Obama administration hopes to expand that number to 7 million by the end of 2017.
 
There are several IDR plans and the terms vary considerably. Some IDRs require borrowers to pay as much as 20% of their annual income and the length of these plans can extend up to 25 years or even 30 years for students who consolidate their loans. In 2012, the Department of Education introduced a more generous IDR called PAYE (Pay As You Earn). It allowed borrowers to make payments amounting to 10% of their discretionary income over a period of 20 years (U.S. Department of Education, 2012). In 2016, the DOE rolled out a second IDR labeled REPAYE. REPAYE’s payment terms are essentially identical to the terms of the PAYE plan, but REPAYE expanded eligibility standards to allow more borrowers to qualify (Stratford, 2016). The Department of Education has announced a goal of enrolling 2 million more people into IDRs by the end of 2017, which would bring total IDR enrollment to 7 million student loan borrowers (Stratford, 2016).
 
At least in the short term, IDRs can be useful to student borrowers because monthly loan payments are determined based on the borrower’s income and not the amount owed. Thus an individual who borrowed an enormous amount to attend college or graduate school, but is unable to find a well-paying job, can enroll in an IDR that sets monthly payments that can be quite low.
 
Unfortunately, these income-driven repayment plans are no silver bullet for easing the student loan crisis. In fact, IDRs have significant downsides that are outlined below.
 
IDRs UNREASONABLY LENGTHEN THE PERIOD OF STUDENT LOAN INDEBTEDNESS
 
First, these programs can extend debtors’ loan repayment obligations for long periods of time, generally 20 to 25 years. Thus, long-term repayment plans force college graduates to pay off their student loans over the majority of their working lives. Moreover, many student loan debtors do not sign up for long-term repayment plans immediately after finishing their studies. Many borrowers struggle with their loans for several years before opting for a long-term repayment plan as the only viable strategy for avoiding default. For these people, long-term repayment plans can stretch into their retirement years and beyond.
 
Brenda Butler, for example, whose bankruptcy case was decided in 2016, graduated from Chapman University with an English degree in 1995. She borrowed $14,000 to finance her studies (Butler v. Educational Credit Management Corporation, 2016). Over the years, she made loan payments when she could. However, she suffered periods of unemployment and often worked in low-income jobs. Nevertheless, over a period of 20 years, she made loan payments totally $15,000, a little more than she borrowed.
 
Unfortunately, accrued interest and penalties caused Butler’s total indebtedness to grow to more than double what she borrowed. In 2012, 17 years after graduating from college, she entered a 25-year income-driven repayment plan.
 
In 2014, Butler filed for bankruptcy in an effort to shed her student loan debt, but an Illinois bankruptcy judge refused to grant her relief. Consequently, Butler was obligated to continue making monthly loan payments until 2037, 42 years after she completed her undergraduate degree!
 
The Butler case may seem extreme, but it is not. In a case decided in March 2016, a student loan creditor argued that Rita Gail Edwards, a 56-year-old single woman who had accumulated $243,000 in student loan debt, should be placed in either a 20-year or a 25-year income-driven repayment plan. Under the more generous of those two plans, Edwards would only be required to make monthly payments of $56 a month, but she would not finish making loan payments until she was 76 years old.
 
Fortunately for Ms. Edwards, an Arizona bankruptcy judge rejected the creditor’s argument and discharged her student loan debt in its entirety. The court pointed out that Edwards’ income level was so low that she is barely eking out an existence. In addition, the court estimated Edwards’ working life would extend for no more than eight years and that it would be impossible for her to pay off her quarter-of-a-million debt unless she acquired “the winning Powerball ticket” (Edwards v. Educational Credit Management Corporation, 2016, p. 21). The court concluded that in such circumstances the creditor’s offer of a 20- or 25-year repayment plan was unreasonable.
 
A review of recent bankruptcy court decisions shows that the U.S. Department of Education and its contracted debt collectors routinely oppose bankruptcy discharge even for debtors who are elderly or in extremely dire economic straits. The DOE even opposed bankruptcy relief for a student loan debtor who as a quadriplegic (Myhre v. U.S. Department of Education, 2013). Thus, rather than being a humane option for distressed student loan debtors, IDRs have in fact been used as a blocking tool by the federal government to prevent insolvent student loan debtors from obtaining bankruptcy relief.

MONTHLY PAYMENTS FOR MOST IDRs ARE OFTEN TOO LOW TO COVER ACCRUING INTEREST
 
Secondly, monthly loan payments under IDRs are often so low that they do not cover accruing interest on the underlying debt. This means that most IDR participants are seeing their loan balances increase even though they are faithfully making their loan payments.  At the end of the repayment term, which can be 20 or 25 years, the federal government forgives the student loan debt that has not been repaid. However, the U.S. Internal Revenue Service considers the forgiven loan amount as taxable income.
 
A 2013 New York Times story describes an example of how student loan balances can grow under income-driven repayment plans (Segal, 2013). The Times reported on a woman who borrowed $312,000 to obtain a degree from a veterinary college in the Caribbean. Although she obtained a job as a veterinarian, her salary was not large enough for her to service her student loan debt under a ten-year repayment plan. Thus, she signed up for a 25-year income-based repayment plan, which featured a much lower monthly loan payment. However, because her monthly loan payment was not large enough to pay the accruing interest, her loan balance continued to grow larger. The Times estimated that at the end of her 25-year repayment period, her loan balance would double to $650,000!
 
The Edwards case that was discussed above also illustrates this point, at least implicitly. In that case, Edwards, at age 56, owed $243,506 in student loans. Her student loan creditor argued she should be put in an IDR where she would make monthly payments of as little as $56 for 20 years. Although the court did not state the interest rate on her student loans, it is clear that $56 a month would not cover accruing interest on a $243,000 debt under any possible interest rate that has been charged on student loans over the life of the federal student loan program. Had the judge accepted the creditor’s argument, Edwards would certainly owe considerably more on her student loans at the end of her 20-year repayment period than she owed when she began making her token $56 a month payments.

CONCLUSIONS: IDRs ARE NOT A SILVER BULLET FOR SOLVING THE STUDENT LOAN CRISIS

IDRs are touted by the U.S. Department of Education as a way to ease the burden of student loan debt. However, they are no silver bullet for solving the student loan crisis. Although IDRs lower borrowers’ monthly payments, they lengthen the term of indebtedness dramatically and often set monthly payments so low that they do not pay down accruing interest, much less reduce the principal. In such cases, loan balances for people in IDRs grow larger, not smaller. And although unpaid loan balances are forgiven at the end of the IDR repayment period, the unforgiven debt is considered taxable income to the borrower.
 
In short, IDRs are not an effective strategy for solving the student loan crisis. In our view, Congress should revise federal bankruptcy law to allow honest, but unfortunate, student loan debtors to shed their student loan debt in the bankruptcy courts. Forcing overburdened debtors into long-term repayment plans that can extend for a quarter of a century will undermine the ability of people who are overburdened by their student loans from ever getting on their feet financially and improving their financial prospects, which was the reason for taking out student loans in the first place.
 
References
 
Butler v. Educational Credit Management Corporation, No. 14-0769, 2016WL 360697 (C.D. Ill. Jan. 27, 2016).

Cao, A. (2016, October 17). Program to help student loan borrowers fails many who need it most. Money.com. Retrieved here.
 
Edwards v. Educational Credit Management Corporation, Case No: 3:14–bk–16806–PS, Adversary No. 3:15-ap-26-PS, 2016 WL 1317421 (Bankr. D. Ariz. March 31, 2016). Retrieved here.
 
Looney, A., & Yannelis, C. (2015, September 10). A crisis in student loans? How changes in the characteristics of borrowers and in the institutions they attended contributed to rising loan defaults. Washington, DC: Brookings Institution. Retrieved here.
 
Myhre v. U.S. Department of Education, 503 B.R. 698 (Bankr. W.D. Wis. 2013).
Segal, D. (2013, February 23). High debt and falling demand trap new vets. New York Times. Retrieved here.
 
Stratford, M. (2016, April 2). Obama admin sets new income-based repayment goal. Inside Higher Ed. Retrieved here.

United States Department of Education. (2012, December 21). Education Department launches “Pay As You Earn” student loan repayment plan [Press release]. Retrieved here.

United States Government Accountability Office. (2016, December). Social Security offsets: Improvement to program design could better assist older student borrowers with obtaining permitted relief. Washington DC: Author.

Warren, Senator E. (2016, December 20). McCaskill-Warren GAO report shows shocking increase in student loan debt among seniors [Press release]. Retrieved here.