Can Loan Forgiveness Help the Economy?

Melissa Maichle Cohort Default Rates, Federal Student Aid Programs, General Issues in Financial Aid

Federal student loan forgiveness has been a hot topic this year. President Biden is committed to forgiving $10,000 of outstanding debt for all federal loan borrowers and more progressive democrats are pressuring him to raise that amount to $50,000. Assuming that principal will be reduced and the monthly payment recalculated, those repaying student loans outside the income-based repayment programs would end up with more money to spend on other things each month. However, there is some concern that the cost of providing universal loan forgiveness with no means test will far outweigh the resulting stimulus to the economy.

There are approximately 45 million people repaying federal student loans, which would translate into a $45 billion expense by forgiving $10,000 per borrower or $2.2 trillion for $50,000. The individuals benefiting will perhaps have a few hundred dollars of additional disposable income each month. Moody’s Investor Service predicts there will be some short-term benefits to the economy, similar to a tax credit, and long-term benefits including an increase in home ownership or creation of small businesses. A potential negative ramification is the expectation by future college students that they would also be entitled to loan forgiveness, which may lead to less responsible borrowing.

Prior to these proposals, student loan forgiveness has been targeted in two ways – based on career choice (teacher loan forgiveness, public service loan forgiveness) or on lack of resources (income contingent repayment, PAYE, REPAYE). This would be the first time loan forgiveness would be considered with no obligation on the borrower and no means test. Borrowers already paying based on income are unlikely to see any benefit from this type of forgiveness other than an earlier cancellation of their debt. Also, private educational loans are not included, so those borrowers may only benefit if having a lower federal loan payment allows them to accelerate payments on their private loans.

Finally, because of the anticipated cost of the program, the best course of action may be to consider how existing repayment options can provide a similar benefit, just at a different time. For example, all of the income-based repayment options offer loan forgiveness (now tax-free for all programs!) at the end of the repayment term if there is still a balance, plus offer a lower monthly payment for those who qualify. Additionally, enhancing the public service loan forgiveness program to allow more borrowers to qualify (as of September 2020 just under 90% of borrowers applying for loan forgiveness were found to be ineligible) would also provide more people with relief while ensuring college graduates are still able to afford to enter public service.