Student loans are imposing crushing burdens on millions of young Americans. According to one account, about one-quarter of the borrowers who began repaying their loans in 2005, 2007 or 2009 have since defaulted on them.
That number greatly understates the economic hardship, not to mention the daily anxiety, produced by the pressures of repayment. What if there was an easy way to respond to the student debt crisis? A response that did not involve heavy-handed regulatory interventions?
Such a response is identified in new research by James Cox and Daniel Kreisman of the Andrew Young School of Policy Studies and Susan Dynarski of the University of Michigan. Their recommended reform is stunningly simple: Change the default plan offered on StudentLoans.gov. (This “default” refers not to the failure to pay back federal student loans but to a pre-selected option, in which borrowers are enrolled in the program if they do not actively opt out of it.)
As the federal website is now constructed, borrowers are automatically enrolled in the standard plan, which calls for a 10-year fixed repayment. But for most borrowers, there is a safer and smarter choice: an income-driven repayment plan, or IDR for short.
The advantage of IDR is that it gives borrowers significant protection if they fail to find jobs or if their salaries are low. Repayments are limited to a percentage of borrowers’ discretionary income (usually 10 percent to 15 percent) above a specified threshold (typically 150 percent of the poverty line).
There is an additional benefit: Loans are forgiven after a certain period, such as 25 years. Why, then, are there so few takers?
Cox and his collaborators tried to answer that question by creating an online facsimile of StudentLoans.gov and asking participants — residents of Georgia with a family size of one — to choose a plan. This was an experiment, not a real loan, but the researchers created monetary incentives to ensure that participants would take the task seriously.
As in the real world, a strong majority of participants chose the standard plan when it was the default option. But when the website’s design was changed so that IDR was the default option, about two-thirds of participants ended up choosing it. As the authors put it, “The government has a very easy policy lever to pull if it wants to increase uptake of income driven repayment plans.”
Many people think that when people are choosing poorly, it’s best to provide them with clear, simple information. But when participants were informed about the distribution of earnings among recent college graduates — a clear signal that for many people, IDR might well be best — they nonetheless stuck with the standard plan if it was the default. Surprisingly, information did not help.
It is true, of course, that IDR is not best for everyone. If borrowers can repay their loans over a 10-year period, the standard plan is better, because they pay interest over a shorter period of time. For that reason, it might make sense to include a clear notation on the website explaining to people that while the standard plan is riskier, it works well for some borrowers.
Making the IDR the default would not do anything to help people who are currently struggling to repay their loans. For them, more ambitious ideas are worth considering; some of these proposals would help future borrowers as well.
There’s a broader lesson. Those who design plans and options often fail to see the power of the default rule. That failure even has a name: “default neglect.” Many people think that if applicants do not like the default option, they will reject it.
The problem is that inertia is an immensely powerful force — sometimes for better, sometimes for worse. In the context of student loans, it is hurting a lot of people. The Department of Education should change that, and sooner rather than later.
Cass Sunstein is a Bloomberg Opinion columnist.