Income-Driven Repayment Plans for Student Loans: Budgetary Costs and Policy Options

The volume of outstanding student loans has grown considerably over the past decade as the number of borrowers and the amounts they borrow have increased. In the 2018–2019 academic year, the government issued $76 billion in new loans to 7.6 million students. Overall, as of December 2018, outstanding student loans issued or guaranteed by the federal government totaled $1.4 trillion—or 6.8 percent of gross domestic product (GDP).

Between 1965 and 2010, most federal student loans were issued by private lending institutions and guaranteed by the government, and most student loan borrowers made fixed monthly payments over a set period—typically 10 years. Since 2010, however, all federal student loans have been issued directly by the federal government, and borrowers have begun repaying a large and growing fraction of those loans through income-driven repayment plans. Required repayments in such plans depend not only on a loan’s balance and interest rate but also on the borrower’s income.

On average, borrowers in income-driven plans make smaller monthly payments than other borrowers, and the plans provide loan forgiveness if borrowers have not paid off their balance after making payments for a certain number of years. For those reasons, loans repaid through income-driven plans are more costly to the government than loans repaid through fixed-payment plans.

How Do Income-Driven Repayment Plans Differ From Other Repayment Plans?

Introduced as a way to make student loan repayment more manageable, income-driven plans reduce the required monthly payments for borrowers with low income or large balances. Under the most popular income-driven plans, borrowers’ payments are 10 or 15 percent of their discretionary income, which is typically defined as income above 150 percent of the federal poverty guideline. Furthermore, most plans cap monthly payments at the amount a borrower would have paid under a 10-year fixed-payment plan.

The earnings and loan balances of borrowers in income-driven plans determine whether they will repay their loans in full. Borrowers who have not paid off their loans by the end of the repayment period—typically 20 or 25 years—have the outstanding balance forgiven. (Qualifying borrowers may receive forgiveness in as little as 10 years under the Public Service Loan Forgiveness, or PSLF, program.) CBO estimates that most borrowers in income-driven plans initially make payments that are too small to cover accruing interest—and therefore, over the first several years of repayment, their loan balances grow rather than shrink. If those borrowers eventually earn enough to make larger payments and fully repay their loans, they generally pay more than they would have in a fixed-payment plan.

CBO also found that borrowers default on their loans at much lower rates in income-driven plans than in other plans. Default rates are probably lower for loans in income-driven plans because payments are reduced for borrowers who have lower income and are less able to pay. But borrowers who opt in to the plans might be less likely to default for other reasons—for example, because they are more aware of their financial options.

How Has Enrollment in Income-Driven Repayment Plans Changed Over Time?

The number of borrowers in income-driven plans grew rapidly between 2010 and 2017 as the plans became available to more borrowers and their terms became more favorable. Among borrowers who had taken out direct loans for undergraduate study, the share enrolled in income-driven plans grew from 11 to 24 percent. Among those who had taken out direct loans for graduate study (and for undergraduate study as well, in many cases), the share grew from 6 to 39 percent.

The volume of loans in income-driven plans has grown even faster than the number of borrowers because borrowers with larger loan balances are more likely to select such plans. In particular, graduate borrowers have much larger loan balances, on average, and are more likely to enroll in income-driven plans than undergraduate borrowers. CBO estimates that about 45 percent of the volume of direct loans was being repaid through income-driven plans in 2017, up from about 12 percent in 2010.

What Are the Budgetary Costs of Income-Driven Repayment Plans?

By law, CBO follows the procedures specified in the Federal Credit Reform Act of 1990 (FCRA) to estimate the costs of the student loan program. Under FCRA, a loan’s lifetime cost to the government is described as a subsidy and is recorded in the budget in the year the loan is disbursed. The subsidy is measured by discounting all future cash flows associated with the loan—including the amount disbursed, the principal and interest paid, and debt collected from borrowers in default—to a present value, or current dollar amount. (The administrative costs of disbursing and servicing loans are not included.)

On that FCRA basis, CBO estimated in its August 2019 baseline budget projections that if current laws remained unchanged, $1.05 trillion in federal student loans would be disbursed to students between 2020 and 2029, increasing the deficit by $10.7 billion. (Those estimates exclude PLUS loans to the parents of students, which are not eligible for repayment through most income-driven plans.) Loans repaid through income-driven plans were projected to result in larger subsidies than loans repaid through fixed-payment plans. Specifically, CBO estimated that $490.4 billion in disbursed student loans would be repaid through income-driven plans, with a subsidy of $82.9 billion, and $562.7 billion in loans would be repaid through fixed-payment plans, with a negative subsidy—in other words, a gain—of $72.2 billion. For those loans, the government’s projected cost as a percentage of loan dollars disbursed, known as the subsidy rate, is 16.9 percent, on average, for income-driven plans and −12.8 percent, on average, for fixed-payment plans.

CBO also estimates the costs of student loans using the fair-value method, which reflects the compensation a private investor would require to undertake the risk associated with those loans. In August 2019, CBO estimated that the fair-value subsidy of the loans disbursed to students between 2020 and 2029 would be $262.8 billion; loans repaid through income-driven plans would have a subsidy of $211.5 billion and a subsidy rate of 43.1 percent, and loans repaid through fixed-payment plans would have a subsidy of $51.4 billion and a subsidy rate of 9.1 percent. (The costs of student loans appear larger when estimated using the fair-value method because it accounts for the cost of market risk—the risk that arises because borrowers are more likely to default on their debt obligations when the economy is weak.)

The costs of loans repaid through income-driven and fixed-payment plans differ not only because of the terms of the plans but because of the borrowers who enroll in them. In particular, borrowers who select income-driven plans tend to borrow more money. CBO also expects the average subsidy rate of loans in income-driven plans to be higher for loans to graduate students than loans to undergraduate students, mainly because graduate students take out larger loans, which are less likely to be paid off.

Of the loans disbursed from 2020 to 2029 and repaid through income-driven plans, CBO estimates that undergraduate borrowers would have $40.3 billion forgiven and graduate borrowers would have $167.1 billion forgiven. (Those forgiven balances, which include unpaid interest, are discounted to their value in the year the loans were disbursed to make them more comparable to the original disbursement.) The forgiven amounts are equal to 21 percent of the disbursed amount for undergraduate borrowers and 56 percent of the disbursed amount for graduate borrowers. For comparison, the present value of payments on the same loans is equal to 84 percent of the disbursed amount for undergraduate borrowers and 82 percent of the disbursed amount for graduate borrowers. (Because accrued interest is included in the calculations, and interest rates on student loans are higher than the discount rate, loan payments and forgiven balances add up to more than 100 percent of the originally disbursed amounts.)

The repayment of student loans affects not only federal spending but also tax revenues. In both fixed-payment and income-driven repayment plans, student loan interest is deductible in the tax year in which it is paid. Those tax deductions reduce federal revenues. In addition, borrowers in income-driven plans whose loans are forgiven have the unpaid balance included in their taxable income for that year (unless the loans are forgiven through the PSLF program). The resulting tax revenues partly compensate the government for the cost of forgiven loans. However, income taxes that would be forgone through deductions for interest payments or collected on forgiven balances are not included in the estimated budgetary costs of income-driven repayment plans in this report.

What Are Some Options for Changing Income-Driven Repayment Plans?

CBO assessed the costs of two broad sets of options for changing income-driven repayment plans. One set of options would change the availability of such plans. The other would change borrowers’ payments. CBO analyzed how the options would affect the government’s costs through 2029 if they applied to all loans taken out by new borrowers as of July 1, 2020. In addition, CBO separately examined how the costs of loans to undergraduate and graduate borrowers would change under the options.

The options were selected for this analysis either because they are similar to policies that lawmakers have considered in the past or because they illustrate how sensitive the plans’ costs are to certain policy parameters.

Options That Would Change the Plans’ Availability
The three options in this category would change the availability of income-driven plans by making the Revised Pay as You Earn (REPAYE) plan the only income-driven plan, by making the REPAYE plan the only repayment plan, or by making fixed-payment plans the only repayment plans. The second and third options are diametric alternatives: enrolling all student borrowers in income-driven plans or eliminating income-driven repayment entirely. In CBO’s estimation, the second option would increase the subsidy cost of loans by $36 billion from 2020 to 2029; the third would decrease the subsidy cost by $122 billion over the same period.

When estimating the effects of changing income-driven repayment plans, CBO focused on the REPAYE plan for two reasons. First, it is the newest income-driven plan. Second, the plan does not cap borrowers’ payments, which is also true of the income-driven plans in most recent Congressional proposals to modify the student loan program.

Options That Would Change How Borrowers’ Payments Are Calculated
The three options in this category would change borrowers’ payments in income-driven repayment plans by changing the portion of discretionary income used to calculate payments, the definition of discretionary income, or the timing of loan forgiveness. Each of those options was analyzed in conjunction with the first option from the previous set—that is, CBO considered the REPAYE plan to be the only income-driven plan in each case.