The Trump administration is planning a major overhaul of the federal student loan system that will affect not just borrowers but also the companies that currently service the more than $1 trillion in outstanding debt owed to the federal government.
The Department of Education announced on Friday that it will seek to offer what amounts to a monopoly on loan servicing to a single company, rather than splitting the work between a handful of different private sector firms and public-private partnerships that currently collect payments on the loans.
The department didn’t signal which of the existing vendors is favored, if any, but in a release indicated that consolidation is expected to save money.
The change “maintains superior customer service and key borrower protections while ensuring the project stays on budget, saving taxpayers more than $130 million over the next five years.”
But while most borrowers won’t be greatly affected by the entity collecting their payments, another change to the system being considered by the Trump administration would have a very real effect on new student borrowers.
First of all, the administration is said to be considering a plan to do away with a program put in place by the Obama administration that offers special student loan forgiveness to people who choose a career of public service, a benefit open to more than half a million people, and which was expected to kick in later this year.
The Trump plan would also change another Obama-era rule that forgave the balance of a student’s debt after he or she paid 10 percent of their income over 20 years. The new plan would raise the percentage to 12.5 percent annually, but reduce the duration of the program to 15 years.
It’s worth gaming out how this would be different for borrowers. Imagine two hypothetical students who both graduate from college at the same time carrying substantial student debt. Both of them get jobs that pay $50,000 per year to start, and for purposes of this example, assume both remain in the same occupation for 20 years, receiving 2.5 percent raises every year.
In the first year, a student paying a maximum of 10 percent would have to dedicate $5,000 to student loan payments, while a student under the new Trump rules would pay $6,250. As their incomes increase, the difference in their annual payments also rises. By year five, the borrower under the Trump plan is paying $1,380 more per year than the borrower under the current system. By year 10, the difference is $1,561 and by year 15 it has ballooned to a $1,766 difference.
However, after year 15, the borrower under the Trump plan has the remainder of the debt forgiven, having paid out a total of $112,075 over the 15-year period. The borrower operating under the current system still has five more years to go, and by the time year 20 rolls around, will have paid $127,723.
Who benefits more isn’t necessarily obvious here. It’s tempting to assume that the person who pays more money over time is the loser, but that ignores the fact that someone with an additional $1,250 or more to spend every year could invest all or some of that money.
If the borrower paying 10 percent of income over the first 15 years invested an extra $1,000 every year and earned a modest 4 percent return, that would add up to something over $20,000 at year 15, already more than the difference between what the two borrowers would have paid by the time their loans were forgiven.
All of this, of course, hinges on Congress accepting the Trump budget’s recommendations, which is still an open question.