David P. Lewis
Yesterday, the Obama Administration announced a series of steps that it plans to take to make college more affordable and to make it easier for students to repay their federal student loans. These steps include:
- Caps on monthly loan payments. Currently, student loan borrowers participating in an income-based repayment (IBR) plan can limit their loan payments to 15% of their discretionary income and can have the outstanding loan balance forgiven after 25 years of payments. In 2010, Congress adopted a changed IBR plan that, beginning on July 1, 2014, will allow student loan borrowers to cap their monthly payments 10% of their discretionary income. The new proposal will allow approximately 1.6 million students to cap their loan payments at 10% of their discretionary income starting in 2012 and will also provide for the balance of any outstanding loan to be forgiven after 20 years of payments instead of 25 years.
- Loan consolidation. For student loan borrowers with both outstanding guaranteed FFEL loans and Direct Loans, the new proposal will allow borrowers to consolidate their FFEL loans into the Direct Loan program beginning in January 2012. The purpose of this consolidation is to simplify the repayment process by allowing borrowers to make only one monthly payment instead of two or more. In addition, the consolidation proposal would provide, for borrowers who take advantage of the consolidation, a 0.25% interest rate reduction on their consolidated FFEL loans and an additional 0.25% interest rate reduction on their entire consolidated FFEL and Direct Loan balance.
While the merits of the proposal, including the President’s authority to take this action by executive order and the Administration’s claim that the actions “carry no additional cost to taxpayers,” will be debated, one potential issue with the proposal for proprietary schools is already apparent. Under Section 668.7(b)(3)(i)(C)(1) of the gainful employment regulations that were finalized last June and became effective on July 1, 2011 (see our summary of the final regulations and recent updates on the rules here, here, here,and here), the Department of Education limited the degree to which payments made by a borrower in the IBR plan could count toward a school’s repayment rate. Specifically, for a borrower in the IBR plan that makes scheduled payments on the loan during the most recently completed fiscal year included in the ratio for an amount that is equal to or less than the interest that accrues on the loan during the fiscal year (so-called interest only or negative amortization loans), the dollar amount of the loan that is counted in the numerator of the repayment rate ratio is limited to 3% of the total amount of the original outstanding principal balance (OOPB) of the loan that is included in the denominator of the ratio.
To the extent that the Administration’s proposal causes greater numbers of student loan borrowers take advantage of the new IBR plan, which is to be expected, more loans will likely fall into the categories of interest only or negative amortization loans. If so, then, as to any given school under the current repayment rate calculation, more of its students’ outstanding loans would be subject to the 3% limitation (i.e., fewer would be counted as being successfully in repayment), and, consequently, the school’s repayment rate will be negatively impacted.
This adverse impact appears to be an unintended consequence of the new proposal, and a proposal that is intended to benefit all student borrowers should not come at the expense of the proprietary sector. Fortunately, the current gainful employment regulations anticipated that adjustments may need to be made to the 3% limitation. Under Section 668.7(b)(3)(i)(C)(3) of the regulations, the Secretary has the authority to adjust the 3% limitation, up to the estimated percentage of all outstanding Federal student loan dollars that are interest-only or negative amortization loans, by publishing a notice in the Federal Register. Such an adjustment should be considered and made.