Written By Travis Hornsby, CFA®, CFP®
The Biden administration has announced they plan to modify the terms of the original Revised Pay As You Earn (REPAYE) plan to allow most borrowers to pay significantly less while receiving interest subsidies at the same time.
The White House wants to provide a smooth transition into repayment and reduce default. It’s also quietly created a policy that will deliver more financial benefits to student loan borrowers than any other student loan program ever announced.
The Department of Education estimates the net budget impact at $137.9 billion. That’s a massive understatement of the benefit to current and future borrowers. The Department admits that their estimate does not incorporate the strong possibility of “increased take up” of IDR plans and increased borrowing resulting from more generous loan terms. We will try to tackle these omissions in this post.
Modeling the cost of the New REPAYE plan is incredibly difficult and requires making numerous big assumptions. We will estimate the 10-year cost of the New REPAYE plan and show why it’s a much bigger deal than even student loan cancellation, both in its cost and benefit.
How many borrowers could benefit from the New IDR Plan?
The REPAYE plan was always the one income driven repayment option available to all Direct Loan borrowers regardless of when they took out a loan for the first time.
In the unofficial proposed rules for New REPAYE, the Department of Education published an estimate of a representative borrower cohort for FY 2024 broken down by undergraduate and graduate degree status and by income level. They did this to try to estimate the cost of the New REPAYE rules.
If we extrapolate and assume this representative sample of borrowers represents student loan borrowers overall, we can get an idea of how many student loan borrowers currently exist by degree and income type (there are approximately 43.5 million total borrowers).
All these borrowers could theoretically benefit from the New REPAYE plan, but the million-dollar question is what adoption rate would there be?
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Savings for borrowers currently on an IDR plan
To measure savings for current borrowers, we’ll use numbers provided by the Department of Education for the average payment reduction for each class of borrower.
Given that there are approximately 9 million borrowers on an IDR plan currently and about 20% of undergraduate borrowers use an IDR plan, we’ll make assumptions for how many borrowers there are in each category and what the average payment reduction could be.
Do these payment reduction numbers estimated by the government make sense?
These payment reduction numbers are over the life of loan repayment. It’s unclear exactly how the government estimated this, but if we assume a typical undergrad borrower might pay back her loans over 10 years, a 10-year payment reduction of $12,329 would be about $1,200 lower a year, or $100 less a month in payments thanks to the New REPAYE plan.
That kind of a change in payments at least makes intuitive sense.
The Department of Education assumes that high-income graduate borrowers would see their payments increase on the New REPAYE plan, perhaps because of paying back loans for 25 years instead of 20 years.
This assumption is faulty because it assumes borrowers on the Old IBR plan will not switch, that borrowers who could benefit from lower payments by filing separately will not do so, and borrowers who could benefit from 20-year repayment terms will not stay on plans that offer them. It also assumes that borrowers will not take advantage of lower New REPAYE payments and switch before the 10-year period of payments locks them into New REPAYE.
It's more plausible that the typically high-income graduate borrower might be able to lower her payments by a couple to a few thousand per year with advanced-level planning like that offered by companies like us.
But we will use the Department of Education’s estimates until the end, where we might look at different assumptions for the payment change for graduate borrowers.
Related: Will Borrowers Need to Enroll in PAYE to Remain on It?
Savings for borrowers who would join IDR with the new benefits
How many borrowers who previously were repaying their loans would sign up for the New REPAYE plan to receive some amount of loan forgiveness in the future?
Before the pandemic, about one-third of borrowers in repayment were on an income driven plan.
This New REPAYE plan is so generous that, at a minimum, one would expect at least 50% of borrowers overall to adopt it. It guarantees that your balance will not grow thanks to interest subsidies along with ultra-low payments for undergraduates, which virtually assures at least a 50% rate of take up.
If information flows to borrowers efficiently, we could see up to 80% of borrowers signing up for an IDR plan overall as more lower-income borrowers opt to go to school and students become less price sensitive about educational investment.
More borrowers than ever before will be considered to be on an IDR plan by more generous definitions
Keep in mind that a borrower in numerous types of deferments and involuntary forbearances will now receive credit towards IDR forgiveness.
In addition, borrowers who default will be automatically enrolled into IBR after 75 days, where possible.
The old system did not count deferment, forbearance and default towards repayment credit. Nine million borrowers are on IDR now, and if about one-third of borrowers sign up for IDR overall, that means about 27 million borrowers were in some kind of repayment status pre-pandemic.
After these new rules are in place, that old way of defining repayment will no longer apply.
So we will estimate New REPAYE entrants based on a range of 50% to 80% of overall borrowers eventually ending up on an IDR plan, and the majority of borrowers would choose New REPAYE as it would be the most generous for approximately 90%.
So if 50% of borrowers sign on to IDR, that’s an additional $178 billion in cost. If 80% of all borrowers are on IDR (inclusive of all the deferment and forbearance statuses that now count), that’s an additional $334 billion on top of the $113 billion estimated above.
How many new students will join higher education programs?
Economics tells you that if you subsidize something, you’ll get more of it.
Presumably, with more generous loan terms, institutions of higher learning will seek out new students to enroll in their programs that might have otherwise assumed they couldn’t afford it.
If we assume that 10% more students go to college, 50% end up on an IDR plan and that they are distributed like the cohort above, that would cost approximately $28 billion.
If 80% ended up on IDR, that would cost $45 billion.
This part of the cost estimate is highly variable. One would also prefer to count the cost of the IDR subsidy overall for this group that previously would not have had debt, but a great measure of that is difficult to choose.
How many new students will borrow additional loans they wouldn’t have previously?
In 2016 according to Brookings, undergrad students could have borrowed an additional $105 billion and chose not to. Graduate students could have borrowed another $79 billion and chose not to.
If you have increased confidence that the marginal cost of borrowing is low or zero, you will choose to take out additional loans to fund expenses like rent and food instead of savings.
Most of the additional amount borrowed would be a pure cost borne by society overall instead of the individual or their family for these marginal borrowing cases.
Borrowers take out 10% of their eligible unused loan amounts as of 2016, and we assume 90% of this extra borrowing gets discharged on IDR, which would be an extra $165 billion in cost over 10 years.
How big is the interest savings on New REPAYE?
Perhaps the largest understatement of costs by the Department of Education comes on page 132 of the cost estimates of New REPAYE. See the chart below.
The Department of Education estimates a 10-year cost of $15 billion for subsidizing interest on the New REPAYE plan.
The average student debt is about $37,000.
A family of three with both spouses earning $50,000 a year, one of whom owes $37,000, would pay $523 a month under the Old REPAYE plan. He would receive zero interest help from the 50% REPAYE subsidy because his payment covers his interest.
This is the case for the vast majority of current undergraduate borrowers. They do not qualify for any interest subsidy because they are not allowed to exclude their spouse’s income and because they do not get as big of a poverty line deduction.
If this family files taxes separately, they would use a family size of two instead of three under the new rules. His new payment would be $23 a month. His interest subsidy would be nearly $1,700 annually. If his family size was one, he would get a subsidy of about $500 a year.
Far more borrowers will sign up for IDR due to the new rules, which means far more borrowers will receive an interest subsidy.
Let’s assume the typical borrower gets a $1,000 interest subsidy they were not getting before. That feels very conservative based on some of the examples we have run modeling the REPAYE interest subsidies, particularly for graduate borrowers with the largest balances.
Assuming just $1,000 of additional subsidized interest per year per borrower who might sign up would give a cost range for the interest subsidies of between $239 billion and $383 billion over 10 years.
The New REPAYE subsidies are not that dissimilar to the student loan pause for many
Recall that the cost of pausing student loan interest for all borrowers during the pandemic was around $5 billion per month.
Given so many borrowers will pay little to nothing on their loans and a likely majority of borrowers might sign up, the above numbers make more sense.
$239 billion over 10 years is almost $24 billion a year, or $2 billion a month.
It’s unclear how the administration arrived at only $15 billion in interest costs.
You can argue that much of the subsidized interest would have been forgiven anyway, and so it’s not really a cost, but that’s not how the current budgetary rules would measure an impact like subsidizing interest the way the Department of Education plans to do.
What impact would New REPAYE have on tuition inflation?
Several years back, Georgetown Law School officials were recorded saying that they planned to use the PSLF program to raise tuition aggressively and pay the IDR payments of future graduates with current students’ money and that the government would not be able to change the rules because so many people would come to depend on the program.
Other schools like NYU dental have drastically increased tuition as new graduates will make the same payments under IDR plans with $300,000 of loans as with $700,000.
Grad school tuition inflation has already had time to run up thanks to the uncapping of borrowing limits from Grad PLUS in 2006 combined with the IBR, PAYE and REPAYE programs.
What impact would New REPAYE have on undergraduate and graduate school tuition once higher ed administrators realize there’s zero marginal cost being felt by their students in most cases?
There will certainly be faster tuition increases than would otherwise be the case, but how big?
Estimating tuition increases based on subsidized loans
The NY Fed published research showing for each $1 increase in subsidized loan limits, schools increased tuition by 60 cents.
In other words, schools capture 60 cents on the dollar of the government making loans more affordable.
The unsubsidized loan limit for an undergrad is about $2,000 to $4,000, depending on tax status.
There are approximately 3 million students using in-school deferment at the moment.
Let’s assume that New REPAYE is effectively turning unsubsidized loans into subsidized loans.
The loan limits are far greater for unsubsidized loans for grad school.
About 32 million borrowers have $677 billion of Unsubsidized and Grad PLUS loans currently.
Of the 3 million who are using in-school deferment, if we just assume they have the same breakdown of loans, they have about $67 billion of unsubsidized loan need yearly.
So that increase in “subsidized” loan availability might be expected to cause schools to expand tuition revenues by 60% of that figure, or about $40 billion.
How much of that increase in tuition would be covered by student loans and forgiven through an IDR plan?
If we just assume one-quarter of it, which feels low, that’s $10 billion a year. Over 10 years, that’s an additional $100 billion from tuition inflation due to the New REPAYE plan.
New REPAYE total estimated cost range: $824 billion to $1.14 trillion
Here’s what the total budgetary cost and benefit to borrowers might look like summing up all categories we estimated above over 10 years:
- Lowering IDR Payments for Current IDR Borrowers: $113 billion
- Lowering IDR Payments for Payment Plan Switchers to IDR: $178 billion to $334 billion
- New Enrollments: $28 billion to $45 billion
- Increased Borrowing: $165 billion
- Interest Subsidies: $239 billion to $383 billion
- Tuition inflation: $100 billion
Note that the above costs would be significantly lower if the Biden administration were to successfully implement the President’s student loan cancellation plan.
The Department of Education’s estimate only comes in at $137.9 billion due to not attempting to measure dynamic effects like the ones above.
It’s also possible that there could be an increase in borrowers finishing degrees, buying homes, starting families and making other life choices that could increase economic growth and offset the costs listed above.
But regardless, New REPAYE is clearly a huge win for almost all borrowers, although not all borrowers should choose it (some graduate degree borrowers would be better off on PAYE or New IBR due to the shorter forgiveness schedule).
New REPAYE benefit is a windfall for borrowers, but it might not be safe long term
The President has broad authority over IDR plans thanks to the ICR statute from the 1990s.
President Biden is altering the terms of the already existing REPAYE plan and blocking off new enrollment in the PAYE plan after July 2023.
He cannot block enrollment in New IBR due to statute for those who qualify.
Many borrowers have PAYE in their loan promissory notes, but they will be blocked from signing up anyway.
Additionally, the REPAYE plan is being amended to avoid the look of yet another IDR plan.
But some borrowers will be worse off, particularly those with very small debt-to-income ratios with spouses who filed taxes separately and chose the PAYE plan.
If borrowers can be made to be worse off by a President amending the rules of an existing IDR plan, then could a future Republican President block entry into the REPAYE plan or amend its rules to make it far less generous?
Such is the peril of executive action when hoping to achieve long-term, durable policy gains.
It’s also possible that the plan will prove too popular to undo once in place.
But what’s clear is the proposed New REPAYE plan is the biggest policy benefit given to student loan borrowers ever, even when including student loan cancellation.
Not sure what to do with your student loans?
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