The details of the long-awaited student loan forgiveness program are more substantial than expectations. The headlines will highlight the $10,000 forgiveness for borrowers with income below $125,000 (household below $250,000), but the income-based repayment change, including changes to the maximum monthly payments and changes to interest calculations will have a far greater impact (we will be watching changes to consumer spending as well as if tuition rate increases accelerate further).
Additionally, the relief of $20,000 for borrowers who received Pell Grants is more debt relief than anticipated. The current pause on repayment of government-backed student loans is extended to January 2023.
Debt Relief Details.
Individuals with student loans held by the Department of Education can receive up to $20,000 in debt cancellation. The debt cancellation is $10,000 for borrowers with income less than $125,000 or household income below $250,000. Borrowers who received Pell Grants (and meet the income requirements) are eligible for an additional $10,000 for a total of up to $20,000 in debt cancelation.
The Biden Administrations highlights that 43 million borrowers will be impacted by this action, with 20 million borrowers having the entirety of the student loan debt canceled. The Biden Administration defends the additional debt cancellation for recipients of Pell Grants as a way to further target debt relief, as 93% of Pell recipients are from households with income less than $60,000 (66% below $30,000). 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 are now capped at 5% of a borrower’s discretionary income, a reduction from the current 10% cap — an estimated savings of $1,000 annually for borrowers (while the fact sheet shows examples with some borrowers receiving significantly greater savings).
The Biden action will also change the calculation of what is considered non-discretionary income to 225% of the federal poverty level. This change will result in $0 monthly payments for borrowers earning $31,200 (or $15 an hour). Borrowers with original loan balances of $12,000 or less will have loan balances forgiven after 10 years of payments — this is being promoted as a way to create a debt-free community college program after 10-years of payments.
Interest Calculation Changes are a Massive Change.
Negative amortization of student loans are ending under the Biden plan. Going forward, if an income-based repayment does not cover the interest charged, the loan balance will not continue to grow. Any browsing of “student loan Twitter” has countless examples of ever-increasing student loan balances despite years of repayments.
This effect was created by the income-based repayment programs that did not cover the interest owed and advocates argued it was creating debt traps borrowers could not escape. In connection with the new 5% income-based cap, this is a fundamental overhaul of the student loan program.
Student Loan Pause Extended.
Current borrowers have had the moratorium on student loan repayments extended from August 31 to January 2023. The current moratorium began in March 2020, in response to the coronavirus. Borrowers will have almost three full 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 has created a better overall consumer credit environment and has increased the discretionary income of borrowers who have been free to allocate their student loan payments to other expenses, increase their savings, and/or cushion the impact of inflation.
The Biden Administration is also proposing an expansion of the Pell Grant program and make community colleges free (but this remains unlikely). We are also likely to see legal challenges to the President’s authority to implement these changes. Democrats have argued that the President/Secretary of Education has the ability to modify existing student loans under the Higher Education Act, while critics argue that the authority is more limited.
We view the income-based repayment cap and the changes to the calculation of interest as the most significant longer-term impact of this announcement. There will be an immediate economic benefit for the 20 million borrowers who will have their entire student loans canceled. However, the lower repayments, including the increase in the non-discretionary calculation will allow low and middle income borrowers greater discretionary income, which should be a net positive for consumer discretionary spending.
One likely consequence of this change is that we could see a continued increase in tuition growth. The 5% cap and interest forgiveness will shift more of the cost of college education to the federal government and borrowers will feel less impact of tuition increases if their total repayment does not change. Individuals who are not eligible for this assistance are likely to see an increase in their cost of attendance for higher education.