From a borrower’s perspective, the effects of the Prosper Act on student loans will help some and hurt others, but it’s not the groups that you think. By my math, a number of graduate and professional students would pay their loans until death if the current Republican student loan plan passes.
I’m not going into a political or moral discussion as to whether policymakers should pass or block student loan reform. I simply want to make folks aware of how this student loan news could be gamed and cause unintended consequences for everyone involved. So let’s take a look at these proposed new student loan laws.
The Prosper Act’s Big Omission: No Maximum Repayment Period
The Republican student loan plan would cap the federal borrowing limit at $235,500 for medical professionals. A lower cap of $150,000 would exist for other grad school programs like law and business.
These loans would be called Federal ONE loans. Borrowers would pay 15% of their discretionary income unless they chose to make level payments over a set number of years.
To explain the structural issue with the Federal ONE loans, imagine you sign up for a 30-year mortgage. You get a set payment every month for the next 30 years. That payment is part principal, part interest.
If that 30-year loan was for $300,000 at a 5% interest rate, you would pay $279,767 in interest over 30 years and $300,000 of principal, for a total of $579,767. The 30-year mortgage is the standard of the housing world.
In the student loan world, the standard is the 10-year loan. This is what you get signed up for by default if you ever fail to submit your income driven paperwork on time. The 10-year standard plan involves paying the same amount of money each month for 10 years.
If you had $200,000 of student debt at a 7%, you would pay $78,660 of interest over 10 years for a total of $278,660.
The proposed Federal Loan Program says that you must calculate the principal plus interest of doing a 10-year repayment plan with the government. This dollar amount is what you must pay back before your loans are forgiven.
If a borrower left school with $200,000 at a 7%, she would need to pay back $278,660 before she’s square with the government.
If that borrower was a high-earning physician paying 15% of her income, she would get rid of the debt in a hurry. However, if she earned less, she might be paying for a very long time, since the forgiveness terms require her to pay back a specific dollar amount.
A Departure From the Status Quo of 20-25 Year Repayment
The longest repayment term if you’re going for forgiveness is currently 25 years under the IBR and REPAYE plan. When it comes to considering student loan forgiveness with the PROSPER Act, Trump’s proposed student loan plan would create a new maximum of 30 years for repayment for grad school loans.
If you could stretch your loans out for longer than 30 years, would you be crazy to consider it?
This big loophole could help some borrowers if you look at the cost in today’s dollars, but perhaps the stress wouldn’t be worth it.
To see what I mean, imagine you borrowed $200,000 for school and had to pay back $300,000 on the Standard 10-year plan. That sounds bad, but what if you could pay it back over 60 years thanks to income-based repayment?
Notably, the new Federal ONE loans would be forgiven without any tax penalty whatsoever. That’s in stark contrast to the current system.
A multi-decade repayment plan sounds like an option that would allow you to pay back a fraction of the original amount borrowed thanks to inflation.
We need an example to really see how this works.
How the Prosper Act Could Make Student Loans Take Decades to Get Rid Of
Elaine the veterinarian borrows the maximum $235,500 under Prosper.
Unlike undergrad loans, grad school loans accrue interest. Usually, professional school students leave with tens of thousands in finance charges when they walk across the stage to get their degree.
Hence, Elaine would leave school with about $276,000 even though she only borrowed $235,500. That’s assuming a 7% interest rate over a four-year program.
The principal plus interest cost of a Standard 10-year repayment plan with the government would be $396,172. It’s technically a bit more complicated than that, as the government might not capitalize her interest she accrued during periods of deferment, but it will be close to this figure.
That means Elaine must pay 15% of her discretionary income until she hits a cumulative dollar amount of $396,172 in payments.
Elaine’s salary starts at $70,000, goes up to $80,000, then increases at the rate of inflation. Based on this salary trajectory, it would take her until 2052 until her loan obligation is met if we pretend she graduates in 2018.
Check out the calculations I made below showing Elaine’s 34 year-repayment period.
Explaining Prosper Act Income-Driven Repayment
The first column above shows the total dollars paid out of pocket on three different repayment programs. The first is the Prosper Act, which requires the Standard 10-year dollar payments but with 15% of discretionary income.
You’ll notice that the Standard 10 year requires the same exact dollar amount of payments. Private refinancing in the row below that is a 10-year 4.5% loan.
The next column entitled “Total Cancelled” shows the amount of debt that is forgiven, which only happens under the Prosper Act. Elaine would have $556,028 wiped away in 2052 and would pay $0 in taxes. Her first monthly payment on the plan would be $497.
The present value column shows the cost in today’s dollars, assuming Elaine could invest and get a 5% return. This $170,720 cost in 2018 dollars is much smaller than the original amount she borrowed, making the Federal One income-based repayment plan a great option compared to refinancing.
One of the tricks I use for clients in my student loan consulting service is to make sure you save the max allowable in your 401k if you’re going for loan forgiveness. In doing this, you reduce your student loan payments.
If Elaine the veterinarian put the $18,500 max in her 401k, the reduction in student loan payments would make her loan repayment last until 2063. That’s 45 years after graduation in this simulation.
Those with Steady Salaries Under $60,000 Could Take Their Student Loans to the Grave
What about a chiropractor, let’s call him Harry, who earns about $60,000 adjusted for inflation for the duration of his career? Under the current system, his school can ask him to borrow the cost of attendance, whatever it is.
Under Prosper, he only gets $235,500. I’m betting the school will want him to borrow all of it, leaving him with the same $276,000 after including accrued interest during school.
Here is the cost of his loan repayment using Federal ONE loans.
2061, that’s a long repayment period.
What if he saved the max in his 401k? That would reduce his taxable income by $18,500, which reduces his student loan payment. Recall that he has to pay back $396,172 until his loans are eligible for forgiveness.
Because of his lower payments, Harry the chiropractor would be done with his student loan payments in 2088. That’s 70 years after Harry would graduate based on this spreadsheet.
If Harry is still alive, he’d be in his mid-90s.
Even though the idea of nonagenarians paying back student loans is frightening, notice the insanely attractive cost in today’s dollars of his loan repayment at a little over $65,000.
That $65,000 cost in today’s dollars is laughably low compared to the original principal. It’s almost as good as the Public Service Loan Forgiveness program is currently in terms of purchasing power of the dollars the borrower pays.
When Paying Your Student Loans Back Until You’re Dead Could Be Smart
In running numbers and comparing the proposed Federal ONE loan program to the current Federal Direct program, low-income borrowers could benefit enormously in terms of purchasing power of the dollars they must repay.
Currently, borrowers with a low income are on the hook to pay taxes on the forgiven balance after 20-25 years to the IRS. With Federal ONE loans, there will not be any taxes due.
The only requirement is that you pay back a set number of dollars based on your Standard 10-year total principal plus interest payments all summed up.
If you’re forced to pay an exact number of dollars, you want to pay it back over as long a period as possible.
That’s why each time we modeled loans above, the cost in today’s dollars decreased as the borrower’s income decreased.
High-Income Borrowers Would Gain from Lower Tuition Prices But Would Be Forced to Refinance
For high-income borrowers, the Prosper Act would help some by pushing down tuition prices, particularly in the medical, dental, and veterinary world.
Many law schools if restricted to the $150,000 limit would probably go out of business. I expect the higher cost private law schools to be some of the biggest opponents of this bill.
That could be a good thing though, as most of the graduating attorneys would have a number that could be realistically repaid even on an $80,000 small firm salary.
How I Expect Schools to Game the Current Prosper Act Bill
If you were a dean of a professional school program faced with the Prosper Act, how would you game it to maximize your own revenue?
Right now, the Grad Plus program allows students to borrow up to the cost of attendance. That means some schools like NYU Dental put some of their students in over $550,000 in debt by the time they graduate.
Of course, the high-cost schools don’t receive all of that money. Student loans cover things like housing, food, travel, and entertainment that they don’t get a piece of.
That said, if the max students can borrow is set low, and you run a law school in DC or med school in Boston, rent and living expenses take out $20,000 to $30,000 a year or more in what you can charge students for tuition.
What I think might happen is that the schools will wall off that $235,500 for their tuition and will encourage family and significant others to pay for the cost of living out of pocket, with credit cards, or other sources of debt coming from outside the federal loan system.
With most administrators concerned with rankings, research, and reputation, I believe that many different professional school programs will magically start having a cost very close to the maximum allowable federal loan limit of either $235,500 for most medical programs or $150,000 for others.
What Would Happen to Tuition with the Prosper Act?
Unquestionably, the price of a graduate degree would fall under this bill. The Prosper Act would also restrict access more, as some schools will opt for a higher acceptance rate. They’ll tell students who need funds for living expenses that they can’t help.
For future dentists and physicians, the private sector will likely pick up the slack and make sure access to programs is not limited based on economic background. They’re not doing this out of the goodness of their heart, but rather because lenders like making low risk, high-profit loans.
I predict there will be fewer attorneys, chiropractors, veterinarians, and other professionals who start out under $100,000 in income on this bill. Programs will either close down or just try to target applicants from affluent backgrounds.
It’s clear to me after running the math that the House GOP has put forward a well-intentioned plan in the effects of the Prosper Act on student loans that would cause some lower-income graduate degree borrowers to pay for the rest of their lives.
Even though the numbers suggest paying loans for a long time might be financially friendlier than you’d think, I don’t think the political optics of this are going to fly given these student loan changes.
Grandma should worry about relaxing and playing cards, not sending in her income-based payment forms. This is a reality that I expect will be reflected before we get a finalized student loan reform bill.
With the state of Washington, I honestly wouldn’t be surprised if the Democrats just wait out the Republicans until the next election, put their own plan forward, and we have gridlock in the student loan world.
The one thing I know is that if you know the rules inside and out, there will always be ways to game the system and save more money than folks who don’t know the rules.
If you’re already dealing with a big debt loan, feel free to reach out and see how we might be able to help you figure out a plan in spite of all this confusion around the future of student loans in America.