The Facts Ma’am, Just the Facts

Question:  

Would you provide details on President Biden’s student loan relief program? 

Answer:

The student loan relief package has brought emotional and extreme responses from both ends of the spectrum. For that reason, we’ll focus only on the facts of this announcement rather than fairness and whether the bailout will be found unconstitutional by the Supreme Court.

The specific highlights are $10,000 forgiveness for borrowers with income below $125,000 (households below $250,000), and income-based repayment changes, including modifications to maximum monthly payments and interest calculations, will have a far-reaching impact.

Debt relief details

Individuals with student loans held by the Department of Education could receive up to $20,000 in debt cancellation. The debt cancellation is $10,000 for borrowers with income less than $125,000 (household income below $250,000). Borrowers who received Pell Grants (and meet the income requirements) are eligible for an additional $10,000 in loan forgiveness for a total of up to $20,000 in debt cancellation. 

The Biden Administration estimates that 43 million borrowers will be impacted, with 20 million borrowers having all student loan debt canceled. According to the White House, 93% of Pell Grant recipients are from households with income less than $60,000 (66% below $30,000) which is the basis for Biden’s defense of this additional debt cancellation. The Department of Education is setting up a program to certify income for eligible borrowers.

Income-based repayments cut in half

Monthly student loan repayment amounts will be capped at 5% of a borrower’s discretionary income, down from the current 10% cap (an estimated savings of $1,000 annually for borrowers) with some borrowers receiving significantly greater savings. The calculation of what is considered non discretionary income will also change to 225% of the federal poverty level resulting in $0 monthly payments for borrowers earning $31,200 (or $15 an hour). 

Interest calculation changes are a massive shift

Negative amortization of student loans is ending under Biden’s plan. Going forward, if an income-based repayment doesn’t cover the interest charged, the loan balance won’t continue to grow. This combined with the new 5% income-based cap is a fundamental overhaul of the student loan program.

Student loan repayment pause extended

In March of 2020, the current moratorium on student loan repayments began in response to COVID-19. As of August 31, 2022, this has been extended to January 2023 meaning that borrowers have had almost three years with no student loan repayments and zero interest accrual on accounts. The lack of any student loan delinquencies during this period (you can’t be delinquent if you do not have a payment) arguably created a better overall consumer credit environment and increased discretionary income of borrowers who’ve been free to allocate student loan payments to other expenses. 

What’s next?

The Biden Administration is also proposing an expansion of the Pell Grant program and making community colleges free (but this remains unlikely). We’ll likely see legal challenges to the President’s authority to implement these changes. Democrats have argued that the President/Secretary of Education can modify existing student loans under the Higher Education Act, while critics argue that the authority is more limited.

The bottom-line

Changes to income-based repayment caps and interest calculations will have the most significant long-term economic impact. There will be immediate economic benefits to the 20 million borrowers who’ll have their entire student loan balance canceled. The lower repayments, including the increase in the non discretionary calculation will presumably provide low- and middle-income borrowers greater discretionary income. 

One likely consequence of this change is continued increases in tuition growth. The repayments and interest forgiveness will shift more of the cost of college education to the federal government and ultimately to taxpayers. Borrowers will feel less impact of tuition increases if their total repayment doesn’t change. Individuals who aren’t eligible for this assistance are likely to see an increase in their cost of attendance for higher education. We’ll be watching to see if there will be changes to consumer spending and how much more tuition rates may increase along with what other consequences may result from this program. Stay focused and plan accordingly.