Question

Income based repayment (IBR) has been championed as a way to reduce student loan defaults by allowing repayment schedules to vary with a person's income. However, they have some potential economic consequences. Describe at least two potential problems with IBR.

Answer 1

Potential Problems with IBR:

1) Encouraging inefficient economic decisions by students and the problem of negative amortization

The operation of IBR make the economic situation worse, because monthly loan payments under the program are tied to salary, not to the amount owed, IBR by this makes the size of the debt irrelevant. IBR will artificially keep alive schools that should not exist specially income student earn coming out cannot support the amount of debt they took on to obtain their degree.

IBR may lead to “negative amortization,” where the monthly payment doesn’t cover the monthly interest, causing the balance to grow even though student is paying on time each month.

2) Increase in Tuition Fees:

The fact that IBR makes the size of the debt irrelevant means that schools can increase tuition without worrying about adverse consequences for their students. The added debt that follows from tuition increase will not be borne by them because anything added to the bottom line will simply be wiped away at forgiveness. Schools benefit from and are happy about these aspects of IBR.