Biden cancels student loans for millions.
Key takeaways
- Previously, President Joe Biden canceled student debt loan for millions of defrauded individuals
- Now, the Biden administration plans to cancel $10,000 to $20,000 for every borrower who earns under $125,000 ($250,000 for couples), affecting an estimated 43 million borrowers
- For borrowers with remaining balances, student loan repayments will begin in January 2023
- While some economists argue that canceling student debt and inflation are intertwined, others believe inflationary impacts will be minimal
This week, President Joe Biden announced the largest ever student debt cancelation package in American history. The news has been met with joy from some – and concern from others.
One crucial question many economists and investors are asking: What’s the relationship between canceling student debt and inflation?
Why student debt cancelation?
According to a White House Fact Sheet, America’s cumulative $1.6 trillion student loan debt remains a substantial burden. Though the costs of four-year colleges have tripled since the 1980s, neither federal student aid nor wages have kept pace to keep higher education affordable.
Studies show that millions of borrowers struggle to build wealth through crucial economic activities like buying homes, investing for retirement, or starting businesses.
Unfortunately, due to high attendance costs, nearly one-third of borrowers have debt without a degree. And a whopping 16% of all borrowers are in default, crushing wages and credit scores alike.
To counteract these impacts, the Biden Administration announced a three-part plan to give borrowers more financial breathing room.
Part 1: Loan forgiveness
The first step is targeted debt relief for loans taken out before 30 June 2022.
The Department of Education plans to cancel up to $10,000 in debt for non-Pell Grant recipients, while Pell Grant beneficiaries will see up to $20,000 in debt forgiven. Eligibility is income-based, with limits set at $125,000 for single borrowers and $250,000 for married couples. Parent PLUS loans are also eligible under this plan.
Thanks to this design, the targeted debt relief will prevent the top 5% of income earners from benefitting from this decision. The White House estimates that 90% of the debt relief will go to households earning under $75,000 per year.
Additionally, to ensure a smooth transition for borrowers with leftover debt or don’t qualify, the pause on loan repayments will extend “one final time” through December. The White House cautions that “Borrowers should expect to resume payments in January 2023.”
Part 2: Slashing monthly payments
Next, the Department of Education plans to institute a new income-driven repayment plan to boost lower-income borrowers’ financial stability. Under this plan:
- Monthly payments for undergraduate loans will cap at 5% of a borrower’s discretionary income, down from 10%
- The bar for discretionary income will raise, meaning some borrowers may have monthly payments of $0
- Loan balances under $12,000 will be forgiven after 10 years of regular payments, not 20
- The Department will cover unpaid monthly interest to keep low-income borrowers’ balances from growing
Moreover, the Public Service Loan Forgiveness program will include new rules to expand eligibility and ensure borrowers receive “appropriate credit” toward loan forgiveness.
Part 3: Holding colleges accountable
The Administration’s third aim hopes to reduce college costs and “hold schools accountable when they hike up prices.”
Among other goals, President Biden hopes to double the maximum Pell Grant, make community college free to attend, and strengthen accreditation practices.
The Department of Education will also publish of watchlist of high-debt, low-earning programs to help students make more informed choices.
How to receive student debt forgiveness
One of the biggest questions is how borrowers will receive forgiveness, and whether said forgiveness will be taxed.
First thing’s first: no, loans forgiven under this plan won’t be taxed, thanks to current regulations set in place under the American Rescue Plan.
Secondly: according to White House information, the Department of Education will “work quickly and efficiently” to set up a simple application to verify income and claim relief. Some 8 million borrowers with income information on hand may not have to file.
Education Secretary Miguel Cardona encouraged borrowers to visit StudentAid.gov for more information and sign up for automatic email updates.
Past and existing student loan forgiveness programs
Prior to this week’s announcement, President Biden had primarily focused on forgiving debts for borrowers who had been defrauded by their educational institutions.
For example, the Department of Education recently canceled $3.9 billion worth of student loans for those who attended ITT Technical Institute. According to U.S. Secretary of Education Miguel Cardona: “ITT’s leaders intentionally misled students about the quality of their programs in order to profit off federal student loan programs, with no regard for the hardship this would cause.”
Through expanding various loan forgiveness programs, President Biden had discharged nearly $32 billion in student loans in just over two years.
This brings up another important point: the difference between cancelation, forgiveness, and a discharge:
- Forgiveness and cancelation occur when a person’s job or the government relinquishes them from the responsibility of paying student loans. Programs that offer forgiveness or cancelation include:
- The current plan of $10,000/$20,000 in forgiveness
- Public Service Loan Forgiveness
- Teacher Loan Forgiveness
- Discharge occurs when a school closure, disability, or fraud absolves an individual from paying off their loans. Programs that offer discharges include:
- Closed School Discharge
- Perkins Loan Cancelation and Discharge
- Total and Permanent Disability Discharge
- Discharge Due to Death
- Discharge in Bankruptcy
Canceling student debt and inflation: Will this make it worse?
One worry that some economists and policymakers have put forward is the link between canceling student debt and inflation. We’ll look at the problem from both angles.
The argument for inflation
One of the most ardent opponents of the administration’s student debt cancelation is Former U.S. Treasury Secretary Larry Summers. He claims that canceling student debt will “tend to be inflationary by raising tuitions.”
Other economists take a different tack, like Harvard professor and former Obama Council of Economic Advisers head Jason Furman. He notes that providing hundreds of billions in debt cancelation could free up hundreds of billions in discretionary income and nullify any deflationary benefits of the recently-passed Inflation Reduction Act.
However, the impacts of student debt cancelation on inflation are likely overblown, according to government data.
A recent analysis from the Committee for a Responsible Federal Budget (CRFB) found that wiping out all $1.6 trillion in student debt would raise inflation no more than 0.5% over 12 months.
While that’s not unsubstantial, the calculation also assumes five times the forgiveness the Biden administration has announced. If all eligible borrowers claim forgiveness benefits, the plan should cost just over $300 billion. As such, canceling student debt may nudge inflation up just a few tenths of a percent.
The argument against inflation
On the other hand, the Biden administration holds that inflationary impacts will be minimal, especially when repayments begin.
Mark Zandi, Moody’s analytics chief economist, sided with government officials, noting that: “The end of the moratorium and targeted debt forgiveness will result in the resumption of billions per month in student payments. This will restrain growth and is disinflationary.”
Joseph E. Stiglitz, a professor at Columbia University and chief economist at the Roosevelt Institute, agrees. According to his analysis of the situation, the proposed student debt cancelation stands to reduce inflation. But if price growth does occur, the plan’s “inflationary impacts will be miniscule, and the long-term benefits to the economy are likely to be significant.”
The reason, according to Stiglitz, is due to the way we estimate canceled student debt. In simple terms, current budgeting practices treat losses from debt cancelation as though they’re occurring this year. However, that’s not entirely accurate.
Instead of handing students a $10,000 or $20,000 stimulus check, the current plan simply forgives the balance. As such, students won’t suddenly have thousands to spend laying around – they’ll just bring home an extra $80-90 per month for the next few decades.
As a result, Stiglitz estimates, the net effects of student debt cancelation may reduce inflation while giving households more wiggle room to save and invest. He also cites evidence that student debt cancelation leads to workers contributing more meaningfully to the economy by getting married, having children, and starting small businesses.
3 priorities for individuals with leftover student loan debt
Biden’s student debt cancelation plan stands to spread hefty benefits throughout the economy. But it doesn’t forgive everyone’s balance entirely.
If you don’t qualify for forgiveness or estimate you’ll still have loans left over, here’s what to prioritize to keep your finances on track while you repay your loans.
1. Your credit score
A strong credit score ensures your future financial opportunities remain open to you.
Your credit score is directly linked to your likelihood of being approved for other loans, rental properties, and credit scores. Your score’s stability also determines the rates you pay on those debts. Typically, the better the credit score and the cleaner your credit report, the lower your rate.
To stay in good financial standing, you’ll want to ensure you make your loan and credit card payments on time, every time.
2. Your budget
To have enough money to save and invest, your income must exceed your expenses. But with inflation accelerating at its fastest pace in four decades, you probably feel like your money isn’t stretching like it used to.
You can minimize some of this impact by making (and sticking to) a budget. Consider the following elements:
- Your income after taxes
- How much money you spend each month on essentials like housing, utilities, loan payments, food, and gas
- How much you spend on extraneous items like entertainment and dining out
- The amount you want to put aside for saving and investing
If all those expenses exceed your income, it’s time to slash some discretionary extras to afford essentials like your student loan payments. (If you’re funding everything but your savings, we suggest cutting back on the takeout to better prepare for the future.)
3. Your Investment Portfolio
Investing isn’t a one-time event; it’s a habit you must maintain to see consistent, positive results. Make sure you’re putting aside money each month to invest in your future. Take some time to do your homework, too, whether you examine your holdings, reallocate your assets, or strategically select your securities.
Alternatively, you can invest in a platform that puts its investors’ interests first, like Q.ai. With a wide variety of Investment Kits, we can take some of the guesswork out of preparing for the future. Our virtual platform enables the everyday investor – you – to access diversified portfolios formerly left to the elite.
Plus, with Portfolio Protection, you can rely on the power of AI to predict and adjust for potential risks for you.
Should I fund my retirement account or pay my student loans?
If you’re struggling to decide between protecting your future or repaying your loans faster, here are a few factors to consider.
1. Your loan’s interest rate
If the interest rate on your student loan is high, you’ll want to pay it down as quickly as possible. Each month you carry a balance is another month that interest can accrue, eating into your capital.
Conversely, if you have a low-rate loan, you may be able to stratify your funds toward retirement savings and paying off the loan in a more balanced way.
2. The effects of compound interest
Compound interest, or the interest earned on interest, can quickly grow a retirement account. The earlier you start saving for retirement by taking advantage of compound interest, the more financially secure you’ll be later.
You don’t want to miss out on the benefits of compound interest by getting hyper-focused on paying off loans. (Unless, of course, your loan’s rate is so high you’ll lose more money in the long run.)
3. Your minimum payment
Making at least the minimum payment on your loans each month is required to avoid default. Depending on your loan’s interest rate and the rate on your retirement account, you may have to decide between paying more on your loans or more into your retirement account. But no matter what, you have to make the minimum payment – or your credit score will suffer.
Canceling student debt and inflation: Not as scary as it seems
So far, evidence suggests that canceling student debts won’t send inflation sky-high, though it’s still too early to tell for sure.
That’s why Q.ai is here to help you prepare for the future. You handle your minimum loan payments and credit score – we’ll take care of your investments.
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