The idea of Joe Biden implementing a massive student loan forgiveness or debt cancellation program continues to gain traction.
In the past, Biden said he supported some debt forgiveness, but he wanted it to come from Congress rather than the President. More recently, Biden has openly explored the possibility of canceling debt with an executive order.
The mere possibility of student debt relief has many borrowers worried that they will miss out if they make payments now. The uncertainty makes it challenging to make debt elimination plans. Traditionally, paying off loans as fast as possible to minimize interest spending was the smart approach. However, quick debt elimination could mean missing out on forgiveness benefits.
Fortunately, it is possible for borrowers to come up with a plan that maximizes any forgiveness benefits without running up massive interest charges.
Identifying Loans Potentially Eligible for Debt Cancellation
If President Biden is going to forgive any student debt, it will almost certainly be federal loans.
This detail is important for two reasons:
- Private loan borrowers are unlikely to miss out on cancellation. If you have private student loans, there is little risk in aggressive repayment. Likewise, there is no harm in refinancing this debt at a lower interest rate.
- Federal borrowers should keep their loans with the federal government. Using a refinance lender to get a lower interest rate is popular, but it converts federal debt into a private loan. Refinancing federal loans likely erases any chance at forgiveness.
If you are uncertain if your loans are federal or private, this guide to accessing the federal student loan records should help.
The Two Forgiveness Amounts Most Frequently Discussed
Another essential detail to discuss is the amount of cancellation up for consideration.
Over the past couple of years, two amounts dominated the discussion: $50,000 and $10,000. While it is certainly possible that a different amount might eventually be forgiven, $10,000 and $50,000 are the most likely. These numbers were not randomly selected.
The Case for $50,000 of Student Loan Forgiveness – The $50,000 figure was first proposed by Senator Elizabeth Warren when she was a candidate for President. While there are many borrowers with larger balances, canceling $50,000 would leave over 36 million borrowers debt-free. In other words, the vast majority of federal student loan borrowers would see their balance drop to $0.
The Case for $10,000 of Student Loan Forgiveness – Cancelling $10,000 of federal debt is more of a targeted strike. Surprisingly, over half the federal borrowers in default have balances less than $10,000. Borrowers who leave school early rack up less debt, but they are more likely to default. The smaller forgiveness amount is designed to give some relief to all, and significant relief to the borrowers who arguably need it the most.
Many members of the Senate support $50,000 of forgiveness. However, President Biden has only advocated for $10,000 worth of forgiveness. He notably rejected the plan for $50,000 worth of forgiveness.
The Student Loan Sherpa Opinion on Loan Forgiveness Amounts: The $50,000 figure has gained a ton of support over the past couple of years, but I don’t see it happening. It’s possible that President Biden could change his mind, but it seems very unlikely at this point. I think the best borrowers can hope for is $10,000 of relief.
Planning for Forgiveness and Making Smart Payments
The big fear for many borrowers is that they make a payment on a debt that could have been forgiven. Nobody wants to be the person who misses out on forgiveness because they paid off their loan a month too early.
If a borrower makes a large payment on a $70,000 balance lowering their balance to $68,000, the risks are minimal. Even the most optimistic would say that cancellation of an amount greater than $50,000 is unlikely.
Things are a bit different if that large payment is used to lower a balance from $50,000 to $48,000. If the maximum amount of forgiveness being discussed actually happens, this borrower would have spent $2,000 unnecessarily. However, the risk in this payment is still relatively low, given the slim probability of the maximum forgiveness happening.
Borrowers with balances of around $10,000 or less are the ones most at risk of making a payment that could have been forgiven. Because the Biden Administration is actively investigating the possibility of canceling $10,000, these small-balance borrowers may benefit from paying as little as possible.
Fortunately, because of the federal interest freeze, there is no danger to borrowers watching and waiting to see how events unfold in the coming weeks and months.
The Cost of Waiting and Hoping for Student Loan Cancellation
The danger in delaying a payment comes in the form of student loan interest.
Once the federal government starts charging interest on federal student loans again, borrowers will have a difficult decision to make. Leaving money in the bank instead of paying down a student loan balance is a bet on future forgiveness. The longer you wait for forgiveness, the more interest the loan generates, and the more expensive the bet on forgiveness becomes.
Suppose you have $1,000 set aside for your federal student loans, but you delay payment in hopes that the debt is forgiven. If the federal loan has a 6% interest rate, the cost of not making that payment is $5 per month, for a total of $60 per year.
Forgiveness has been a serious subject of discussion in Washington for the past couple of years. The borrowers who delayed final payoff during this time have spent two years’ worth of interest in hopes that their debt will get erased. If the debt gets canceled, they come out ahead. If it doesn’t, they spent lost of lot of money betting on politics.
Converting Private Student Debt into Federal Student Loans Eligible for Forgiveness
Sadly, most private loans cannot be converted into federal loans. While there are limited circumstances where converting the debt is possible, most private loan borrowers are stuck with private debt.
The one big exception would be the borrowers who have federal loans that are not “federally held.” These are the federal student loans that are notably not eligible for the current federal interest rate and payment freeze. However, federal direct consolidation offers an opportunity to convert these loans into federally held loans.
Borrowers with loans that are federal but not federally held should consider the possibility that forgiveness may only apply to federally held loans. These borrowers conceivably could go through federal student loan consolidation to gain eligibility for future debt cancellation.
Minimizing Future Payments to Maximize Any Potential Forgiveness
It is estimated that approximately 80% of borrowers have $50,000 or less in federal student loans.
To maximize the benefit of future forgiveness, these borrowers should seek out options to lower their monthly student loan payments. Right now, minimizing payments is easy. The federal interest rate freeze and payment suspension mean borrowers owe nothing and don’t have to worry about the accumulation of interest.
Once repayment begins, Income-Drive Repayment (IDR) plans enable many borrowers to keep payments low. The Department of Education Loan Simulator is a helpful resource for comparing payments across the various repayment plans.
Sherpa Tip: One way to lower IDR payments is to make retirement plan contributions. Borrowers can save for the future, reduce their tax bills, lower monthly student loan payments, and maximize forgiveness.
Ask for a Refund on Previous Payments
If you think student loan forgiveness is on the horizon, getting a refund on previous payments could be a smart move.
During the Covid-19 interest and payment freeze, some borrowers elected to continue making payments. The idea behind this strategy was to knock down loan balances so that repayment is more manageable once the freeze ends.
Borrowers that made optional payments are eligible to get a refund on these payments. A larger balance potentially means more debt to cancel.
Helping the Cause
Those passionate about the importance of debt cancellation and forgiveness policies can take steps to support the cause.
- Call your leaders in Congress. The more people calling about student loan forgiveness, the more likely it is to happen.
- Speak up on social media. Right or wrong, many Americans form their opinions on public policy based upon what they read on social media. As more people get behind debt cancellation, polling numbers will move and increase the odds that Congress makes a move.
- Support free community college and/or free undergraduate programs. One of the big roadblocks in forgiving debt is knowing the problem will come back when new borrowers graduate and expect forgiveness. A one-time debt-cancellation is easier to swallow. If we fix the ridiculous price of higher education, canceling out student loans becomes more palatable to Congress.
Have a Backup Plan
Student loan forgiveness or cancellation is far from a certainty… so borrowers should have a backup plan.
One of the best ways to protect yourself is to start saving to pay off your student loans. Instead of making extra payments on the loan, you put the money in a bank account. That Plan B bank account can also serve as a large emergency fund.
If forgiveness happens, you have a chunk of money that can be a down payment on a house or set aside for retirement. If the $50,000 of student loan forgiveness doesn’t happen, you have money to knock off a huge portion of your balance.