I didn’t think this day would actually come, but here it is. The Biden Administration has announced it will be taking executive action to cancel a portion of federal student loan debt for millions of borrowers. The student loan cancellation comes at a time when federal student loan payments have been paused with covid-19 being the justification.
This announcement has several components. Let’s break it down to understand how this may impact you and what comes next. I will also briefly share my thoughts toward the end.
The announcement made by the Department of Education has four major parts: cancellation of a portion of federal student debt for qualified borrowers, an extension of the pause on payments and interest, changes to interest accrual and income-based repayment plans, and changes to the Public Service Loan Forgiveness Program.
Some of these parts are proposed regulations, so they are not immediately effective. Let’s address each in turn.
Student Loan Cancellation
The biggest aspect of this announcement is the “cancellation” of a portion of millions of borrowers’ federal student loan balances. Not everyone will qualify, but many will.
Qualifying loans must have been first distributed on or before June 20, 2022. The loan must actually have been disbursed, as opposed to merely “originated” to qualify.
There are also income limits. Single tax filers are eligible if they earn up to $125,000 per year. Married households are eligible if they earn up to $250,000.
The cancellation is limited to either $10,000 or $20,000, depending on what federal aid a student received in college. Students who received a Pell Grant are eligible to have $20,000 taken off their balance. Students who did not are eligible for $10,000.
The likely justification for this is that Pell Grants are awarded to students deemed financially needy, and these graduates would therefore also need more relief than non-Pell Grant recipients.
As of now, no balances are charged off. You still owe what was taken out. This is an announcement of what is planned. Any such action will likely take months before it takes effect. And there will likely be lawsuits, as the action rests on what I believe to be dubious legal grounds.
UPDATE 8/30: The Secretary of Education announced the three-step process being set up. More details will be forthcoming and I will watch for these developments.
Remember that, for now, no balances have been charged off. We still need to wait and see what rules will be put into effect, and what legal challenges may be brought. Stay tuned for more updates in the coming weeks on this.
Extension of the Pause on Federal Student Loan Payments and Interest
Since March of 2020, the federal government has placed a freeze on payments and accrual of interest for federal student loans. During this time, borrowers were able to make payments, but would not be penalized if they did not. The extension has been renewed a number of times since the initial pause.
The most recent pause was scheduled to end on August 31. I predicted that there would be another extension. The latest announcement states that there will be a final freeze on payments and interest through the end of 2022, nearly three years after this started.
So if you have federal student loans, you do not yet need to make payments, and no interest will accrue on your principal balance. Keep in mind, though, that this is not forever. Many Americans have gotten used to not paying their student loans and I fear for the reality check that is coming if they do not prepare for payments to resume.
Also, keep in mind that this freeze does not apply to private student loans. This only applies to loans made by the Department of Education through its contracted servicers. So, if you have private student loan debt, you must keep making payments and interest will continue to accrue.
Changes to Income-Based Repayment Plans
Many borrowers enter income-based repayment (IBR) plans after they graduate from college or graduate school. For those with large balances, this may seem like the only viable way to stay current with payments and avoid default.
Right now, the federal income-based plan uses a 10% benchmark for monthly payments based on “discretionary income.” But the new rule, if it goes into effect, will change that to 5%. The new rule will also raise the amount of income that is considered nondiscretionary, which will further reduce monthly payments.
Another change proposed is for the end of the IBR plan. Right now, one on an IBR plan can have their balance forgiven after 20 years of payments, depending on the original amount borrowed. But now, that timeframe is being greatly reduced, going from 20 years down to 10 years for borrowers with an original loan balance of $12,000 or less.
Finally, this change would address an issue called negative amortization—when a borrower’s balance goes up, in spite of making minimum payments. The new rule would cover the borrower’s unpaid interest so that a borrower’s balance does not grow as long as he or she makes timely payments.
How this will look remains to be seen, as the proposed regulations have yet to be written. I will be on the lookout for these changes and post another update when we have news.
Changes to Public Service Loan Forgiveness
Another big change in this student loan cancellation announcement relates to the Public Service Loan Forgiveness (PSLF) program. I have written before about how abysmal that program has been for applicants. In the past 2 years, the Department of Education has waived some of its hyper-strict application requirements so that more borrowers will have their balances forgiven.
The changes will allow for partial, lump sum, and late payments, and allow certain kinds of deferments and forbearances without forfeiting the progress made in PSLF. Many applicants have experienced denial after missing one payment, entering a forbearance, or some other obscure excuse.
I have counseled my clients to avoid PSLF because of how tragic its results have been. I will also watch the new changes to the program and look for what the future results are. Ten years is still a very long time to remain in debt and to limit your earnings, so my advice will likely not change much. But for some, it may be viable.
Closing Thoughts on The Topic
I wrote an article some time about on the subject of student loan “cancellation.” I oppose the idea not because I want people to remain in financial bondage, but because the fundamental problems are not resolved by such a move.
The perverse incentives remain for universities to charge obscene tuition rates, and there is no real assessment of the wisdom of borrowing copious amounts for degrees that have questionable returns on investment.
Not to mention the fact that these balances that are “canceled” are merely being transferred from individual borrowers to the national debt. At over $30 trillion, it’s an amount of debt that we cannot really comprehend. Adding more to that balance, and putting the burden on future generations is something I have a problem with.
You can read more about my thoughts on the subject here: Cancel Student Loan Debt: A Financial Coach’s Perspective.
I hope this update helps you understand what is going on. For the time being, I recommend continuing to aggressively pay off your debts. Don’t rely on politicians and bureaucrats in Washington D.C. to fix your life. You have the greatest influence on your destiny. Take up that responsibility and do something great, starting right now.