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Do I Pay Off My Loans or Wait for Forgiveness from Sanders or Warren?

Michael Lux Blog, Strategy 1 Comment

Editor’s Note: This article has been updated on January 16, 2020, to reflect Senator Warren’s plan to forgive student debt without Congressional approval.

Now that Bernie Sanders and Elizabeth Warren have both proposed massive student loan forgiveness, it introduces a complicated situation for borrowers.

Traditionally, paying off student loans aggressively — often utilizing student loan refinancing — was the most efficient way to pay off debt. This path might make less sense now that two major 2020 candidates have each proposed eliminating over a trillion dollars in student loan debt.

The certainty is that interest will continue to accumulate on student debt until it is paid in full or forgiven. The uncertainty is whether or not the proposed forgiveness ever becomes a reality. As we noted in our article about the dangers of betting on Warren delivering forgiveness, getting elected is just one of many steps necessary for it to become a reality.

In the face of this critical uncertainty, borrowers need to ask a couple of essential questions. Should the forgiveness proposals change my student loan plans? If so, how should I adjust my strategy?

Should I just Make Minimum Payments?

Some borrowers may elect to make minimum payments on their student loans in the hopes of maximizing any forgiveness from the 2020 election.

The fear of missing out on debt cancellation/forgiveness can be a big motivator.

Sadly, this is part of the reason that across the board forgiveness will be so difficult. Many people who recently paid off their student loans will be opposed to cancellation and argue that it isn’t fair. Opponents to loan forgiveness will portray these former borrowers as victims and use them as a reason not to support forgiveness. The debate could get ugly.

The most likely form of forgiveness would be through an executive order to reduce existing federal balances. There is some debate as to whether or not a president can cancel the debt, but Elizabeth Warren argues that she could. Thus, a Warren win in 2020 could be an immediate boost for federal student loan borrowers. As such, it would make sense for student loan borrowers to focus on eliminating their private loans while paying the minimum on their federal loans until the 2020 election is resolved.

The less likely form of forgiveness would be the full student loan forgiveness proposals offered by Warren and Sanders. These two proposals include the forgiveness of private student loans and federal government loans. Warren’s proposal would cap the forgiveness amounts, but the Sanders version would forgive all student debt.

For borrowers to get both federal and private student debt forgiven, President Sanders or President Warren would need to get legislation through Congress. Right now, Republicans control the Senate, so such a bill would be unlikely even to get a vote. Even if the Democrats did take back the Senate — and keep control of the House — it would still be challenging to pass. Of the many Democrats running for President, only two seem to be in support of student debt cancellation. It would be hard to get all Democrats to support such a measure, and it is a safe bet that there will be no Republican support.

Those who believe in the likelihood of forgiveness may want to lower their monthly student loan payments to the minimum and start setting aside money in a savings account as a backup plan. Just know that there is a cost to hoping for forgiveness, and it could be an expensive bet.

Should I Delay Refinancing My Student Loans?

In certain circumstances, waiting to refinance student loans might make sense.

Student loan refinancing is one of the most effective ways of paying off loans quicker. Borrowers get lower interest rates, and as a result, the principal balance can get paid off faster.

This site has always recommended that borrowers with federal loans think twice before starting the refinance process. Refinancing federal loans converts the federal debt into private debt. This change means that borrowers no longer have consumer protections such as income-driven repayment plans and student loan forgiveness.

If things go according to plan for Warren or Sanders, the forgiveness will be treated the same for all debt… not just federal loans. In the dream scenario for both of these candidates, refinancing won’t hurt borrowers.

Unfortunately, things don’t always go according to plan, and politicians often have to compromise. One potential compromise might be that federal loans get forgiven, but the private loans do not. This scenario seems possible because it would be much easier for the President to cancel federal debt than it would be to pay off existing debt. With federal debt, the government just stops getting paid. The cost would be spread out over many years. Eliminating private loans would require the government to cut many large checks to many private companies. Such a move would be extremely costly right away.

There is a lot of guessing going on here. We don’t know if any forgiveness proposal will ever become a reality. We don’t know the details on any potential compromise.

That all being said, there shouldn’t be any harm in refinancing existing private student loans. Nothing changes from the government’s perspective, and borrowers can get lower interest rates.

Refinancing federal student loans might still make sense in many situations, but it is worth taking a moment to consider the possibility that some federal debt might be forgiven as a result of the 2020 election. Each borrower can make their own assessment as to how likely the candidates are to deliver on the campaign pledge.

The Best Student Loan Hack Gets Better

One of the best ways to get lower payments on a federal student loan is to contribute extra money to a 401(k) plan, IRA, or other tax-advantaged retirement account. Putting funds in these retirement accounts effectively shields that money from being counted as income for the purposes of calculating monthly payments. In other words, retirement contributions can lower a borrower’s discretionary income.

By putting money in a pre-tax retirement account a borrower:

  1. Lowers their tax bill,
  2. Reduces their monthly income-driven student loan payment, and;
  3. Sets extra money aside for retirement.

This retirement move is one of our favorite student loan hacks.

Those that want to bet on student loan forgiveness-for-all happening can put extra money in their retirement accounts. If forgiveness ends up coming through, they get more debt forgiven. If Sanders and Warren fall short, borrowers can go back to their original student loan strategy… and they will be a little more comfortable in retirement.

Final Thoughts – The Big Picture

Making any major life decisions based upon the promises of a politician running for office seems risky.

Because we don’t have a crystal ball, there is no way to know for sure what will happen and what the best approach will be.

In this situation, the best thing any borrower can do is to seriously consider their options and to make a plan that best fits their needs and their individual circumstances.

If nothing else, the many student loan proposals from 2020 candidates could serve as a good tie-breaker for those struggling to make an important financial decision. If you are weighing aggressive loan repayment against saving for a down payment on a house, the scales might be tipped to saving for that down payment.

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This is great, thank you! While the advice is a bit obvious it is helpful to see the debate that has been going on in my head written out.