Back in March 2020, the Trump administration paused student loan payments for federal loans. It was supposed to be for 6 months originally, though it has been renewed many times. But with the signing of the debt ceiling bill, payments will resume in September, three and a half years later.
Now that payments will resume, the lingering question is whether the student loan payment pause actually benefited borrowers. I maintained throughout that time there would not be a net benefit.
By indefinitely suspending payments, there was an increase in temptation to engage in extra spending. Especially since so many people were struggling with isolation, depression, anxiety, etc., the payment pause offered another avenue to engage in retail therapy.
The data are now in. And this payment pause has not made us better off.
Overall Debt Loads Have Increased
Part of the argument for pausing federal student loan payments was that people could not work due to the Covid lockdowns. One would think that in such a time, more people would be saving money and setting it aside. And for a little while that was happening.
But over time, there was a reversal of that trend. At the end of 2022, there was an increase in household debt at a rate not seen in 15 years. A recent study by the National Bureau of Economic Research attributes this, at least in part, to the student loan payment pause.
Researchers found that by pausing payments, consumers had an increase in spending power. This newfound liquidity became an avenue to acquire more debt rather than pay off existing ones.
For all types of credit, payments and balances increase. By the end of the sample period individuals with a student loan payment pause owe an additional $1,800 in other debt, and pay an additional $20 monthly. Most of the increase in debt is driven by mortgage payments, which tend to be longer maturity, and revolving debt.
Dinerstein, et. al., DEBT MORATORIA: EVIDENCE FROM STUDENT LOAN FORBEARANCE, National bureau of economic research (may 2023), 12.
Student Loan Payment Pause’s Perverse Incentives & Perceptions
The short-term effect of the payment pause was that consumers engaged in more consumption. With historically low interest rates, many Americans saw what they perceived to be great financing offers.
The logical next step is that many consumers added more debt because of that perception. Especially since there was an apparent increase in creditworthiness during this time.
But that increase in credit rating appears to be more due to a curing of existing student loan delinquencies by the pause, instead of consumers climbing out of the hole themselves.
We estimate that the effect on credit scores is concentrated among borrowers who have previously been delinquent on a loan. The payment pause, by curing existing defaults, led to a particularly large change in (perceived) creditworthiness: an increase in credit score of 28 points. Borrowers who had not previously been delinquent see only a modest increase in credit score of just 2 points. Interestingly, we see that the effects on balances and payments for non-student debt are concentrated among borrowers who have not previously been delinquent.
Dinerstein, et. al., Debt Moratoria, 13.
In other words, this increase in credit score was artificial. Those who were delinquent had a newfound borrowing ability. And it seems many took it.
What Will the Long-Term Impacts Be?
Part of my concern about the student loan payment pause was that Americans would become accustomed to not making those payments. By the time payments resume, it will be nearly three and a half years since the Department of Education required payments on federal loans.
What happens to those who have gotten used to a lifestyle without those payments?
Many Americans bought a new house in 2020 and 2021. I’d bet a significant portion of buyers with federal loans used their perceived higher disposable income to buy a house.
But for many of them, this was at the height of the housing market. Buyers, therefore, got very large mortgages. And having observed many closings while working with a real estate law firm, a great number of buyers went into these overpriced houses with very little down.
As of the end of 2022, nearly 250,000 homeowners who bought in 2022 owed more on their house than it was worth. That represents nearly 1 in 12 homes purchased in 2022.
When the student loan payment pause ends, these homeowners are going to have another gut punch. Already their payments are likely higher than the house’s true value due to market distortion. Now there will be minimum payments of likely hundreds of extra dollars per month required of them.
Not a recipe for financial freedom, my friends.
Final Thoughts on the End of the Student Loan Pause
We have about two months until the student loan payment pause ends. Here are my suggestions for what to do if you find yourself mentally scrambling.
First, get a spending plan started. It doesn’t have to be perfect, but start somewhere. Cover your basics first. That means the Four Walls—food, utilities, housing, and transportation. From there, move on to core recurring expenses that are important to your household’s operation. Then move to minimum debt payments, and see what is leftover.
You can read more about how to do this through my guide to making a budget.
Next, create a plan to pay off your debts in a sustainable and systematic manner. I am a big fan of the debt snowball due to its focus on building momentum. But you may also decide that another plan is more effective for you.
You can read about three common plans for paying off debt here. Whatever you choose, find something that resonates with you and stick to it.
And finally, consider reaching out for help. As an experienced financial coach, I help motivated people build confidence, get on a plan, and make good financial decisions. I focus on helping Millennial professionals, but anyone who is willing to be challenged and grow is welcome to connect with me.
Start the conversation today. Don’t let the end of the student loan payment pause get you down. You can beat those student loans, and I’ll show you how.
Book your free Discovery Session today to gain a new perspective, develop new ideas, and take new steps to financial freedom.
