“Fresh start” for defaulted student borrowers should come with broader reforms

Preston Cooper -

Yet again, the Biden administration has announced that it will extend the moratorium on federal student loan payments to August 31, 2022. Continued extensions of the pause are a regressive, expensive policy that will do nothing to address the underlying problems in student lending. But buried in the announcement was an additional policy change that puts the administration on slightly firmer ground.

The Department of Education (ED) will give borrowers who were in delinquency or default prior to the payment pause a “fresh start” and allow them “to reenter repayment in good standing.” During the pause, collections activities on defaulted loans—such as wage garnishment—have been suspended. If ED returns defaulted loans to good standing after the pause ends, collections will not resume unless borrowers default again.

A student loan default crisis

Student loan default is an enormous problem. Prior to the payment pause, 7.7 million borrowers with federally held student loans were in default and another 3.2 million were more than 30 days delinquent on their loan payments. While borrowers should be responsible for repaying their loans, the default crisis is the result of years of irresponsible, no-questions-asked lending by the federal government. In recognition of the government’s complicity, a one-time amnesty for defaulted borrowers is worth considering.

But the Biden administration is wasting an enormous opportunity to pair the amnesty with new policies to prevent future defaults, such as accountability for colleges with high default rates and restrictions on new lending to formerly defaulted borrowers. Without additional reforms, a one-time amnesty will just postpone the default crisis rather than solve it.

The federal government issues $90 billion in new student loans every year, many of which will end up in default. In the year before the pandemic, 1.3 million student loan borrowers entered default. If that level holds after payments resume, student loan defaults will be back up to crisis levels by the middle of the decade.

Moreover, many borrowers who rehabilitate or consolidate their defaulted loans (meaning they bring their loans back into good standing, but still have the debt) do not solve their financial problems permanently. Forty percent of borrowers who exit default this way will default again within five years. If that proportion holds after the administration’s amnesty, over three million of today’s defaulted borrowers will be back in default by 2027.

Irresponsible lending practices led to massive defaults

One reason for high re-default rates is that borrowers in good standing have the right to use federal student loans again. According to my own research at the American Enterprise Institute, 30 percent of people who exit default take out a new student loan within five years. Without solving the problems that led them to default in the first place, allowing those individuals access to federal loans again may just lead them into a deeper hole.

On its own, a one-time default amnesty will not be a permanent solution to the default crisis. Rather than declaring an amnesty and calling it a day, the Biden administration ought to present a plan to prevent new defaults going forward.

Here at FREOPP and in my previous work at AEI, I have proposed a number of policies to address high default rates, including the following:

  • Financial penalties for schools where large numbers of former students default.
  • Accountability for federally dependent programs with a low return on investment. Low ROI is correlated with low student loan repayment rates.
  • Restrictions on reborrowing for students who exit default, including a minimum of 12 on-time monthly payments before access to student aid programs is regained.
  • Easier access to income-based repayment plans, which are proven to reduce student loan default rates.
  • Abolition of Parent PLUS loans, which target vulnerable groups of borrowers.

Congress needs to act

The Biden administration would need to engage Congress to pass most of these policies. But with the right mix of compromises and concessions, a comprehensive plan to pair a one-time amnesty with reforms to prevent future defaults might attract bipartisan support. Congressional action could lead to much sounder policy than the administration’s current strategy of rule by executive fiat.

In the context of broader reforms, a one-time amnesty for defaulted borrowers makes sense. But as a stand-alone policy, the amnesty is just another example of the Biden administration’s guiding principle on student loans: kick the can down the road.