Why Income-Based Repayment Isn't the Only Student Loan Solution

An op-ed piece published in the New York Times this past weekend really got me going.

The writer, an economics professor at the University of Michigan, makes what appears to be a very logical case for instituting a government-sponsored student-loan repayment plan that is exclusively income-based — where installment amounts are linked to paychecks the same way withholding taxes are configured.

The professor argues that doing so would insure students against the downside risks that are associated with our cyclical economy, and also suggests that this type of plan would better serve borrowers and taxpayers (who are the ultimate backstop for these loans) than if rates were to be reduced.

I have four problems with her thesis.

First, administering installment payments couldn’t be more different than collecting payroll taxes. Don’t get me wrong: I am contemptuous of student-loan servicers that have made life unnecessarily difficult for borrowers who want nothing more than a fighting chance to honor their financial obligations. But fair is fair. The management of any payment plan is time- and technology-intensive — and that’s for remittances that are predictable! At the very least, the underlying amortization tables (the systemic allocation of principal and interest over time) would need to be recalculated each time an installment amount varies. Not only is this a laborious process, but it can also lead to errors.

Second, I disagree with the professor’s contention that a reduction in rate is an inferior solution. Sure, the 3% differential that she uses as an example amounts to only $44 per month on $30,000 of indebtedness. But over the life of the typical 10-year student loan, that $44 will total $5,280 in savings — roughly a tankful of gas every month at current prices. More important, however, is the larger matter of interest-rate appropriateness. By that I mean the manner in which interest rates are currently determined for the various Federal Direct and Plus programs — which has little in common with the costs that the government actually incurs to fund and administer these loans. We can thank Congress for that.

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The third problem has to do with routinizing a methodology that was designed (by the feds) to be an exception. If we really wanted to create a universally affordable repayment program, we would instead accept the fact that these loans rival small mortgages in size, and we’d structure them accordingly. Why dilly-dally with an incremental approach that invites loan-servicing errors and added administrative costs, when a 20-year, fixed-payment plan can accomplish the same objective with greater efficiency?

My final concern has to do with the unacknowledged elephant in the middle of the living room: the increasingly high cost of higher education — a trend that is as unsustainable as it is immoral.

As more schools are forced to choose between raising prices, eliminating course offerings and curtailing services, versus depleting endowment funds to the point of financial ruin, perhaps their boards of regents will finally be willing to face some harsh realities. Take for example the wasteful redundancies that exist between schools that operate within close proximity to one another, or how some have strayed from their core missions of delivering quality education by diverting precious capital to the construction of attention-getting facilities.

Imagine what would happen if duplicative administrative functions were consolidated, redundant staff eliminated, and the capital that is today invested in all types of infrastructural warfare was instead used to invigorate educational content, modernize delivery systems and lower prices.

My guess is there would be little need for special repayment plans and a whole lot less worry about our kids’ financial futures.