The Legal Beat
Refunding Student Loans Already Paid Is A Better Idea Than Forgiving Student Loan Balances
Posted on Wednesday November 18, 2020
During his presidential campaign, President-elect Joe Biden said that he supported forgiving $10,000 of student loan debt for every American. While this amount was not as generous as what Senators Bernie Sanders and Elizabeth Warren proposed during their campaigns, it did show that he understood the issue.
Since it is nearly certain that Joe Biden will be inaugurated in January, people are starting to ask what his administration’s forgiveness plan will be. Senate Minority Leader Chuck Schumer and Senator Warren have proposed a resolution calling for the forgiveness of up to $50,000 of federal student loan debt through an executive order. They cite that forgiving student loans will stimulate the economy.
Can the president unilaterally forgive federal student loans? According to an opinion from the Legal Services Center of Harvard Law School, he can. In 2019, President Trump granted student loan forgiveness for disabled veterans. An executive order might be the only option as it is uncertain whether Democrats will control the Senate in January. Even if they did, some Democratic senators may be skeptical to the idea of wholesale loan forgiveness which will be paid by taxpayers, and it only takes one no vote to prevent passage of any forgiveness bill.
Unfortunately, the coronavirus has worsened the student loan problem for many since they have lost their jobs or their usual business income. This means that most people will try to defer or skip student loan payments since food and shelter is more important.
Due to government shutdown orders, businesses must shut down or operate on a limited capacity. This means business will have to lay off employees or shut down altogether. For many people, their only source of income was the extended unemployment benefits. Business owners may have taken the SBA’s Economic Injury Disaster Loan or the forgivable paycheck protection program loan to cover expenses.
While forgiving student loans will be good news for most who are stuck with massive student loans, will Biden’s $10,000 proposal be enough? And will it stimulate the economy in light of the unique challenges presented by the coronavirus? I want to focus on the economic effect (or lack of it) of forgiveness specifically so I will skip the moral arguments for and against forgiveness as well how it will affect people of color.
First, let’s look at whether Biden’s $10,000 forgiveness proposal is enough. For those with relatively low student loan debts, this can wipe out a significant chunk of it. This can give them more flexibility with the remaining balance. It will be easier to negotiate a lower monthly payment plan or refinance with a lower interest rate. Or they may decide to cut the daily lattes and avocado toast for a year and shoot to pay off the remaining loans within a certain time.
But for those with large student loans, forgiving $10,000 will have little or no effect on their finances. Let’s suppose someone has a federal loan balance of $150,000 with the 6.8% interest rate which was the going rate a few years ago. The annual interest alone is $10,200. Similarly, for someone with $250,000 in student loan debt with a lower 4% interest rate, the interest accrual will be $10,000. For those who let interest accrue due to unemployment or making minimal payments, Biden’s $10,000 forgiveness if applied to interest first, will not affect the principal balance.
Even if most or all of the $10,000 were applied to the principal balance, only a small portion of it will be paid off. The interest accrual on the remaining balance will be almost as large and if people cannot pay the interest due to extended unemployment or underemployment, they will be back to where they were financially in a few years.
Second, will forgiveness boost the economy? It is possible that the psychological effect of forgiving loans would encourage people to spend money more freely. But to stimulate the economy, people must have money to spend. And they must be willing to spend it on goods and services, instead of doing financially prudent things such as paying down debts, saving, or contributing to a retirement account.
Forgiving loan balances in itself will not stimulate the economy. Let’s assume someone has no income or is underemployed and has enough money to only pay for fast food value meals. For this person, forgiving loans will not give him more money to spend.
Or to use a more realistic example, suppose someone is on an income-based repayment (IBR) plan and lives paycheck to paycheck spending only on basic necessities. Forgiving student loans will not provide additional money or free up funds for most of these people. So long as they are on an IBR plan, their monthly payment will likely remain the same. And if these people have no discretionary funds left after their expenses, they won’t have any money left to spend.
The coronavirus is not going away anytime soon despite news of promising vaccines. Upcoming shutdown orders due to a spike in cases nationwide will hurt businesses and put more people on unemployment. Forgiving student loan balances is not going to help. While it’s nice to see a lower balance on our student loan bills, it’s not going to put more money in people’s pockets.
I think a better idea is to refund student loan payments already made and make them forgivable. This will provide money to people that can be used to pay for goods and services which will stimulate the economy. Providing refunds is also a more fair solution because it will also benefit those who sacrificed to pay their loans in full. Finally, no limitations should be placed on the refund amount for those with higher incomes in the name of fairness if the main goal is stimulating the economy.
The student loan problem is a complicated one which has only been made worse due to the economic effects of controlling the coronavirus. While forgiving existing student loan balances sounds nice, in most cases, it will leave people in the same financial situation in a few years and isn’t likely to stimulate the economy. Stimulating the economy requires people to have money to spend. Refunding student loan payments already made will accomplish this goal while being fair to everyone.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected] Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.