A few facts about student loans, and one conundru

The facts:

College is expensive. Even taking scholarship aid into account, in-state tuition, room and board at four-year state schools rose 34% over the past decade, adjusted for inflation, while the income of the typical family fell.

Borrowing for college is generally a good investment, perhaps better than for a house. College grads are more likely to have jobs and earn far more than those without a degree.

But borrowing is risky, particularly for those who pick the wrong school or the wrong program or don’t get a degree or can’t find a good job. About 15% of borrowers are in default three years out, meaning they haven’t made a payment for 360 days.

“Are borrowers underwater with their debts exceeding the value of their college education?” asks Susan Dynarski, a University of Michigan economist. No, she says unequivocally. “We have a repayment crisis because student loans are due when borrowers have the least capacity to pay.”

The conundrum:

One prudent way to help college grads reap the benefits of a degree while reducing risk of crushing debt burdens is linking repayment to income: The more you earn, the faster you pay back the loan. If college really doesn’t pay off, you pay less. The notion is an old one: Milton Friedman, the influential conservative economist, advocated it half a century ago.

Since 1993, the government has allowed some borrowers to tie monthly repayment to their income as an alternative to the standard so-much-a-month-for-10 years repayment plan. Borrowers pay nothing unless income exceeds 150% of the poverty level, which is $23,550 for a family of four. If a borrower doesn’t earn enough, the unpaid balance is forgiven after 10, 20 or 25 years, depending on the program. Taxpayers eat the cost.

(Unlike Mr. Friedman’s concept, no one pays back more than he or she borrowed.) Yet only 11% of borrowers in the direct federal student-loan program have signed up after finishing school—and even fewer of those with Federal Family Education Loans and other government-backed student loans.

In all, the White House estimates 2.5 million, or less than 7%, of the 37 million federal student-loan borrowers are in income-driven plans. Many who could benefit, including those who could avoid staining their credit histories with default, don’t participate.

Why?

One reason is that government makes it complicated, as it often does. There are four programs, each with its own rules. Not all borrowers are eligible. Not all loans are eligible. You have to apply. You have to recertify your income each year.

Another reason is that most people opt for the standard 10-year repayment plan. They don’t realize the income-linked plan means you can pay a loan over 10 years if you can, but spread payments out if you can’t.

Many borrowers who fall behind and clearly could benefit don’t enroll. They don’t understand the option, are overwhelmed with the paperwork or are preoccupied with woes that put them behind in the first place. All that has the government and scholars wondering what might make this more widely used.

For starters, the Education Department plans to contact 3.5 million borrowers who are behind in payments or otherwise at risk of default to alert them to the option. The Treasury may send reminders around tax time. And the president wants Congress to expand the program to all federally backed loans, no matter when money was borrowed or what program was used.

That might not suffice. “It needs to be simple, though it should be done in a way that minimizes the extent to which people exploit the system and minimize the extent to which people get ripped off,” says Sandy Baum, a longtime student-aid scholar now at George Washington University.

So Ms. Dynarski and colleague Daniel Kreisman are proposing “a single, simple income-based repayment system to replace the current bewildering array of repayment options.” No websites with decision trees. No forms to fill out when times are tough. And no choice.

For every borrower, monthly payments would be set as a percentage of income: 3% of earnings for the first $10,000, rising to 10% for earnings above $25,000. Allocating between 6% and 9% of earnings would pay off the typical loan in 10 to 15 years; those with lower earnings would end up paying more interest because they’d take more time to pay. Any borrower who hasn’t earned enough to pay off a loan in 25 years would have the balance forgiven.

Loan payments would be deducted from paychecks—just as Social Security taxes are and thus would adjust automatically to rising or falling earnings. That’s a significant simplification for borrowers and perhaps a cost-saver if it avoids defaults, but an added burden on the Internal Revenue Service.

Unlike the existing program, the Dynarski-Kreisman plan—commissioned by the Hamilton Project, a think tank founded by Clinton Treasury veterans Robert Rubin and Roger Altman —would set interest rates high enough to cover costs and defaults; taxpayers wouldn’t be on the hook.

Details may need tweaking, but the basic point is persuasive: The U.S. could use an efficient system that automatically adjusts student-loan payments when borrowers aren’t earning much, reduces delinquencies and defaults, and limits the downside risk to borrowing for college.

Write to David Wessel at [email protected]