Over the past several weeks I’ve had several parents and former students wonder how the various rumblings about student loan balances will impact them, so I thought I would put together a little something on the topic. Right out of the gate, remember that much of this is broad-stroke material and the specifics of any particular program are still undergoing tweaks and changes (hello SAVE and IDR). Further, many borrowers paying on an income driven plan right now are stuck on something called “administrative forbearance,” even though payments were supposed to start back up in October. The remaining loan servicers do not have enough resources to get borrowers back to correct payments and new plans. The likelihood of something happening before December 31st is about as likely as me actually enjoying getting on the treadmill in the mornings – not impossible but highly unlikely….
Let’s put some scope to the issue: Recent estimates place the level of outstanding student loan debt in the US at $1.7 trillion with about one in 6 people owing some amount of debt (~45.3 million borrowers). To further define that “one in six,” we are talking a pretty broad range of age groups with the youngest being your fairly traditional college age and the oldest being a cohort of Social Security collectors (here’s a little-known fact – someone who has defaulted on a federally subsidized student loan can have their Social Security benefits garnished). More than one third of borrowers (at least 15 million) carry loans between $1 and $10k, much of it resulting from loans for non-4-year educations. This is the batch most likely to default since they also are the group that has ended up unemployed or underemployed after a less than enriching college experience (would anyone care for a serving of Trump College? anyone?).
There are already a number of loan forgiveness programs in place for 4-year graduates willing to spend some time doing public service, working in low-income areas, etc… and there is now a proposed rule that would cancel between $10,000 and $20,000 of interest for borrowers who make below a certain income level ($125,000 single income in 2025) and who have a balance that exceeds their original amount borrowed. However, we know that the courts have mostly struck down options for wiping the slate clean, so even partial forgiving of debt means the forgiven amount becomes a taxable event in the year it is forgiven. With any potential for a “forgiving” path, the debtor should plan on setting aside some cash for the resulting tax bill. Forgiving a $10,000 debt for someone working minimum wage would be a tax bill in the range of $1,435 (Fed + NYS). If the payment on a debt of this size averages $120 a month and that’s a struggle, where are these people going to find the money for the tax bill? And lots of borrowers with small balances wouldn’t see much relief, because if you owe $10,000, you might only have a couple thousand dollars of added interest.
Another aspect being overlooked is that the majority of this talk applies only to federal debt – the government can’t forgive private student loan debt, and many parents of former students who supported school with loans do not have any of these loan programs available to them. The government can certainly encourage a private lender to do what might be considered the right thing to do but enforcing it is another thing altogether. If you know someone thinking about refinancing their debt, my suggestion would be to put the brakes on any action until they’ve clearly evaluated all their current AND potential options.
And of course, there are also delays to the Free Application for Federal Student Aid (FAFSA), the application for all students that dictates eligibility for grants, loans and many scholarships. The government passed legislation to simplify the application but it has had lots of intended and unintended outcomes – families with small businesses or more than one child in college come up short compared to past formulas, and the timing of the changes means income protections were not adjusted for today’s inflation. In fact – as I write this the FAFSA portal isn’t even open yet – which typically starts on October 1. The best intentions cause slow-moving bureaucratic chaos…
So here’s my take – the Biden administration has taken the actions they can to eliminate the debt for many of the students misled by predatory colleges and universities, and to temporarily fix forgiveness programs that also misled lenders. I seriously doubt that we’ll ever see a Sanders / Warren type of massive loan cancellation unless a magic genie shows up with a deficit cancelling 7.1 trillion dollars – the system simply needs those dollars either in the form of payments or taxes and cancelling the loans doesn’t get that job done. Besides, if I could call on a magic genie for anything, it would be for financial literacy to become a mandatory topic for everyone even thinking of applying for student loans (parents included) so we can gain some traction on solving the problem before it starts. For parents who are planning to financially assist their children for college in the coming years – keep reading and seek support from a financial planner or college counselor to evaluate your options before you take out any private loans.