This article follows up on Brad’s post from December that discusses what to do about federal student loan forbearance coming to an end. While the new president has extended student loan forbearance, many of the recommendations from the previous article are still relevant: Student Loan Stimulus Ending: What Federal Borrowers Need to Know.
Federal Student Loan Forbearance Now Through September 30th, 2021
Joe Biden began his presidency by signing many executive orders, including an extension on federal student loan forbearance. Making good on this campaign promise means that federal student loan borrowers will get continued relief through the pandemic by having a $0 payment and a 0% interest rate each month through September 30th.
While many borrowers are exhaling with a sigh of relief, some borrowers wonder what other changes are ahead and if there will be substantial government forgiveness. So, what can we expect from the new government’s approach to student loans this year?
Background
During his campaign, President Biden proposed many ideas to reform the federal loan program. When asked about forgiving student debt through executive orders, he made his views clear that any significant changes need to be enacted through government legislation and not by directing the secretary of education to make changes via presidential executive orders.
Legally, does the secretary of education have the authority to forgive large swaths of student loan debt? Probably not.
Senators Elizabeth Warren and Chuck Schumer requested that the president forgive $50,000 of federal debt for every borrower on Day 1 of his presidency. In that scenario, the cost for the American taxpayers would be over 1 trillion dollars. Without a doubt, this would be outside the scope of the secretary of education’s authority and far more appropriate for the House and Senate to decide.
We will see changes this year, but they may take time. In the end, many changes will likely be the result of legislation changes and not that of presidential executive orders.
Problem: The Cost of Free Money
Why don’t we forgive everyone’s student debt?
The challenge is twofold:
- Forgiving student debt is expensive. There is a total of 1.7 trillion dollars in outstanding student loan debt in our country.
- Politicians disagree within their own parties on how to provide additional help for student loan borrowers.
The original version of The Heroes Act proposed forgiving $10,000 per borrower, which would have cost taxpayers $377 billion. The updated version of the legislation that ended up passing in the House limited the $10,000 forgiveness to borrowers who are “economically-distressed,” defined as those whose income is below 150% of the federal poverty level, reducing taxpayers’ cost to $160 billion. Approximately 40% of borrowers qualify as economically-distressed. What is important to note is that even within the Democrat-controlled House of Representatives, $377 billion was too expensive for the budget.
There is also the inevitable tax question that factors into the budget. In traditional loan forgiveness, the amount forgiven passes through to the borrower as income. This means the borrower owes taxes on any amount forgiven. Lawmakers will have to determine if forgiveness should be a taxable event or tax–free, resulting in more cost to taxpayers.
What are the proposed solutions, and what is the likelihood of seeing these solutions come to fruition?
Simple & Effective Solutions
The PAYE Plan Solution
One of Biden’s most straightforward solutions is automatically placing every borrower on the Pay As You Earn (PAYE) plan upon graduating from college. For borrowers who make less than $25,000 per year, they would have a $0 payment and 0% interest on their student loans. Above the $25,000 income number and borrowers would have all the current repayment options at their disposal.
This idea is a no-brainer and would provide much-needed guidance for borrowers graduating today. We will likely see this included in legislation this year.
COVID Stimulus: Potential $10,000 Forgiveness
Biden supported the legislation within The Heroes Act to provide relief for student loan borrowers during the pandemic. In the next stimulus bill, we may likely see the $10,000 forgiveness in some way, shape, or form.
However, we will most likely see the forgiveness apply to federal loans secured for undergraduate debt through public universities, historically black colleges and universities, and minority-serving institutions for borrowers who make less than $125,000 per year.
A New Public Service Loan Forgiveness Program (PSLF)
Another area that seems favorable among most lawmakers on both sides of the aisle is a new PSLF program. Currently, borrowers who qualify for PSLF make 120 payments while on an income-driven repayment plan, at which point the loan is forgiven and tax-free.
Biden wants to flip the back-end PSLF to a front-end forgiveness. Each year a borrower could qualify for up to $10,000 of tax-free forgiveness over a 5-year period of time, thus capping the total PSLF at $50,000 per borrower. This plan is favorable because it is a net-zero plan for budgeting purposes, and it limits the costly tax-free benefit these borrowers receive.
Ultimately these changes would deter borrowers from taking on additional debt above tuition needs. It would also eliminate high-earning, high-borrowing graduate school professionals from getting all of their loans forgiven tax-free after 10-years of repayment. These changes are also highly likely to be included in future legislation.
A New Income-Driven Repayment Plan (IDR Plan)
Biden has proposed a plan to offer a new IDR Plan where borrowers would pay 5% of their discretionary income over 20 years, at which point the loans would be forgiven tax-free. It is unlikely that we will see this materialize as presented because it would cut the amount that borrowers would pay over the life of their loans in half, and the government would need to budget for the tax-free-forgiveness as well.
If we see this plan materialize, it may only apply to undergraduate debt to assist low- and middle-income families while not putting too much stress on the federal government’s budgeting abilities.
No Changes for Graduate Debt
Unfortunately for graduate professionals, Biden’s plans strictly omit graduate debt from any reform. And not surprising when you look at the history of the PAYE and Revised Pay As You Earn (REPAYE) Programs.
These programs were put forth by the Obama administration to make expensive graduate programs attainable for low-income families. As a result, students can borrow the full amount needed to attend expensive graduate programs and affordably eliminate their debt over 20 to 25 years. When these borrowers implement specific retirement planning strategies, most can effectively create a net-zero cost for their graduate degrees.
It is doubtful that we will see any reform for graduate loans as recent solutions have already been implemented. Graduate professionals must continue to exercise a sense of due diligence in their financial planning, budgeting, repaying loans, considering IDR programs, planning for loan forgiveness, and potential tax burdens.
Summary
Without a doubt, we will see changes to student loan legislation this year, and the most significant assistance will provide much-needed aid for low- and middle-income families.
What many people are NOT talking about, however, is that the student loan problem is merely the result of a more significant issue, the cost of attendance (COA). Colleges continue to take advantage of the federal direct loan program unabashedly by substantial increases to their COA year after year.
As a result, students and parents are borrowing more money than ever to pay for college. There is an immediate need to assist borrowers, but the root of the problem lies within college costs.
In the future, we need creative legislation to make colleges and universities affordable for all while maintaining the integrity in our institutions and their ability to offer the best education found anywhere in the world.
Until then, stay informed, plan accordingly, and seek professional advice when needed!
For many families, the high cost of higher education is a daunting proposition. The College Funding Coach is here to help. To learn more about paying for college while saving for retirement, register for one of our free workshops/webinars or speak with a coach to get started on your college funding journey.
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Related Reading:
Student Loan Stimulus Ending: What Federal Borrowers Need to Know