rolling the dice on student loan forgiveness

The Cost of Waiting for Elizabeth Warren to Forgive all Student Loans

Michael Lux Blog, News, Strategy 0 Comments

Editor’s Note: This article was originally published May 29, 2019.  It has been updated to include new information and analysis on Warren’s student loan forgiveness proposal currently in the Senate.

Now that Elizabeth Warren has proposed forgiving most student loan balances below $50,000, some borrowers are considering put a halt to their aggressive student loan repayment strategy.  Instead, they will wait until after the 2020 Presidential Election.

The idea is pretty simple: If I pay off my student loans now and then loans get forgiven, I get zero forgiveness…  If I just make minimum payments, I can maximize forgiveness.

Though this logic is sound, it ignores the risk in the strategy.

The Odds of Student Loan Forgiveness Happening

Thus far, Warren is the only major candidate to have suggested blanket student loan forgiveness for so many borrowers.  While it is certainly possible that another candidate could take a similar position, the chances seem remote.  The position hasn’t resulted in a huge boost in the polls for Warren, and programs like universal health care seem to be far more popular.  As a result, borrowers banking on student loan forgiveness as a 2020 outcome are probably dependent upon an Elizabeth Warren presidency.

Warren has made an identical student loan proposal in the Senate.  However, with a Republican majority in the Senate, the bill is almost certainly dead on arrival.  Even if the bill would somehow get through Congress, President Trump would almost certainly veto the legislation.  If the Warren student loan forgiveness plan is to have any chance at becoming a reality, she will need to get elected President in 2020.

This bet involves some serious risk:

  • Warren would have to get through the primary – According to public records, there are over 250 Democrats that have filed with the FEC to run.  However, only about 20 are considered to be notable candidates with a realistic chance at winning.
  • Warren would have win the general election – Lots will happen between now and November 2020, but it is safe to say that no election is a sure thing.
  • Democrats would have to keep the House and take the Senate – Winning the presidency alone is not enough.  Passing any major legislation will require getting through both houses of Congress and Republican support for student loan forgiveness is highly unlikely.
  • Warren would have to keep her promise – Promises made early in the primaries don’t always become reality.  Warren has rolled out a number of major policy proposals and it will be extremely difficult to follow through on all of them.
  • Another recession could change everything – If the currently strong economy goes flat, it could make student loan forgiveness less viable.  Student loan advocates will certainly argue that student loan forgiveness would provide a much needed boost to the economy, but a recession could change the priorities in Washington.

The Harm in Waiting for Forgiveness

Suppose a borrower has $10,000 remaining on their student loans at an interest rate of 6%.  This borrower could realistically pay off the loan in full, but instead, chooses to keep their money in the hopes that student loan forgiveness wipes out the remaining 10k.

In theory, this sounds like a smart move.  If forgiveness happens, our borrower is $10,000 better off.  If forgiveness doesn’t happen, the borrower can just pay off the balance in a couple years.

The problem is the daily accumulation of interest.  A $10,000 balance at 6% generates $600 per year in interest.  If the borrower in our example waits two years before making a decision, that comes at a cost of $1,200 in interest.

Put another way, the borrower is betting $1,200 that Elizabeth Warren wins and delivers on her forgiveness proposal.  If the bet is a winner, the borrower comes out ahead by $10,000.

Are the odds of the forgiveness happening worth making the bet?  Looking at the numbers, it seems like a bad bet.  The current odds of Warren winning the election are at 4.2%.  The high cost of the bet compared with the low odds of success make it a poor gamble.  In fact, our example borrower would be better off paying off their loans and betting that same $1,200 on Warren in Vegas.  If she gets elected, the winnings would be far more than $10,000.

Obviously the suggestion is not to head to Vegas to make election bets.  The point is that the bet on forgiveness is both expensive and a long shot.

That being said, there are a couple circumstances where waiting in the hopes of forgiveness might make sense…

When to Wait for Warren to Forgive the Loans

The possibility of the student loans being forgiven as a result of the 2020 election is slim, but in some circumstances slim odds might be just enough to tip the scales in strategy.

Borrowers who are on the fence between putting a bonus at work in a retirement fund or towards student debt may decide that saving the money for retirement is the better use.  It isn’t easy to balance saving for retirement with paying off student loans, so the chance at forgiveness might make putting the money towards retirement a bit more palatable.

Along the same lines, borrowers may decide that now is a good time to save for the down payment needed to buy a house.  Purchasing a home can be very complicated for people with student debt, and saving for one goal while hoping the government comes through on student debt might make sense.

Though forgiveness is a remote possibility, sometimes a remote possibility is all that is needed to tip the scales on a financial planning close call.

Borrowers that are going to hope for forgiveness should be careful to make sure that the bet costs them as little as possible…

Making the Wait for Forgiveness Less Expensive

In student debt, as with all forms of debt, the cost of waiting is measured in interest.  The higher the interest rates are, the more expensive it is to hope for forgiveness.

One of the unique aspects of Elizabeth Warren’s plan for student loan forgiveness is that it would apply to private student loans as well as federal student loans.  This means borrowers could refinance their loans at a lower interest rate with lenders like LendKey or SoFi.  There is always the risk that the Warren proposal changes to only include federal student loans, but the refinance option can still serve as a hedge on the bet.

Final Thoughts

Elizabeth Warren’s proposal to forgive massive amounts of student loan debt is bold and it could change the lives of millions of Americans for the better.

Unfortunately, the wheels of government turn very slowly and not all proposals become reality.

Hoping that student loans eventually get forgiven is reasonable.  Delaying payment on a bet that the loans will eventually be forgiven could be an expensive gamble.