With the new SAVE student loan repayment plan, the cost of college is minimal

When the Biden administration launched its new SAVE income-driven repayment plan this year, the news looked really promising for nearly everyone paying off federal student loans. This new plan aimed to cut the average student loan payment for undergraduate loans in half, with a significantly higher number of Americans qualifying for $0 monthly payments based on their income and family size. And current statistics show that more than half of borrowers enrolled in SAVE pay $0 monthly.

In addition, the SAVE program will help borrowers who do not qualify for $0 monthly payments save at least $1,000 annually compared to other income-based programs.

Several other benefits were also presented, including that those who pay less than the interest on their loans would be covered by taxpayers. This means student loan balances will no longer grow when borrowers with large balances pay less than the accrued interest each month.

And of course, borrowers with the SAVE program will have their balances forgiven after 20 to 25 years in the program. People with less than $12,000 in eligible federal student loans could even see their loan balances forgiven in just 10 years in the program.

Moral Hazards of Biden’s SAVE Plan

While the fine print on the SAVE repayment plan certainly sounds nice, there are a number of moral hazards and disincentives. For example, some borrowers may not see the point in trying to increase their income if their student loan payment is only going to increase .

Plus, there’s no reason to pay off student loans faster when the rest you owe is going to be forgiven in 20 to 25 years, right? In fact, there is an entire financial game that borrowers can play to minimize loan payments in order to maximize loan forgiveness – especially for those with large loan balances.

Unfortunately, the SAVE repayment plan brings to light an even worse issue, and it’s one that most of the current administration’s student loan “fixes” consistently fail to address.

Letting borrowers pay a small percentage of their discretionary income (in this case, 5% of income for undergraduate loans and 10% for graduate school loans) regardless of how much they borrow does not reduce the escalating cost of higher education. In fact, plans like SAVE could even encourage institutions to charge higher tuition since they know their “customers” don’t have to pay more after graduation.

The fact is that the SAVE plan does just that Borrowers can overpay for a degree without immediate financial consequences. In fact, someone who borrowed $30,000 for a liberal arts education could have the same monthly payment as someone who borrowed $80,000 for the same degree, as long as their income and family size were the same. The same would also apply to someone who worked part-time during college to keep costs down and only borrowed $20,000 for their degree, so why bother working?

While federal student loans for undergraduates put a cap on how much students can borrow and how much moral hazard there is, the same cannot be said for some federal student loans for graduate students. In fact, graduate students can take out Direct PLUS loans and borrow up to “the cost of attendance less other financial aid received,” according to StudentAid.gov.

Monthly payments for graduate school loans are based on 10% of discretionary income with the SAVE program (instead of 5% with undergraduate school loans), however the monthly payment is still based on income and family size. That means graduate school borrowers could sign on the dotted line for almost any amount of Direct PLUS loans and still make the same monthly payment regardless of their loan balances.

If you are a college that “sells” graduate degrees, there is no incentive to control costs.

Borrowers need to keep costs low

With all that said, there’s a reason for students to try to keep costs down – even if they plan to pay as little as possible on their SAVE loans until their balances are cleared. While student loan balances are currently exempt from being treated as taxable income until December 31, 2025, thanks to the American Rescue Plan Act of 2021, no one knows how forgiven student loan balances will be treated years after that.

Also note that the American Savings Act of 2021 only excludes forgiven balances for purposes of the calculation federal income taxes and that states can (and often do) impose state income taxes on debt that is written off. This means that, after 2025 and beyond, students who have had their debt forgiven under the SAVE income-based repayment program could face a student loan tax bomb in the year their debts are written off.

Obviously, this is a problem that should be considered for all people using the SAVE income-based repayment plan, regardless of how much they borrow. But since having a larger balance leads to more debt being written off and a higher tax bill, this theoretically creates an incentive to borrow less if you can help it.

The bottom line

The SAVE income-based repayment program is just like any other federal program in that it will have its share of winners and losers alike.

The winners are the student loan borrowers who can qualify for $0 monthly payments or low monthly payments for the foreseeable future due to low income, and the losers are every future student who will have to deal with the consequences of schools’ zero accountability for cost control.

At the end of the day, though, the new SAVE repayment plan is going to help far more people than it hurts. The U.S. Department of Education estimates that a higher percentage of people will qualify for $0 monthly payments compared to other income-based programs, and most others will benefit from an average savings of $1,000.

And since unpaid interest will not accrue on loans repaid under the SAVE program when borrowers have low or $0 monthly payments, any future taxation of forgiven amounts still saves borrowers money overall.