This morning, Secretary Devos announced that payments for federal student loans would be suspended. This comes after President Trump announced last week that interest on these loans would be waived. The intention is a good one: leave more cash in the hands of Americans. However, the current plan will not apply to many borrowers which could lead to confusion and resentment for an already troubled program.
The federal student loan program is grossly complex with so many nuances that even experts often fail to appreciate all the intricacies. That creates the problem that interventions, especially ones created in haste, will have unintended consequences. For example last week, after the announcement to waive interest on federal loans, people soon realized that monthly loan payments would not be reduced for many borrowers in repayment. Instead, the same payment amount would be applied to the principle balance. That’s not such a bad thing because it means borrowers will pay less over the life of the loan. But it fails to address current household budget shortfalls. Instead, borrowers pay their loans back more quickly. And to make matters worse, some borrowers would find themselves with a bigger tax bill at the end of 2020 than they would have without this interest waiver. That’s because student loan payments on interest are tax deductible while payments on principle are not.
The announcement today attempted to fix this problem by simply pausing student loan payments. It provided clarity for some borrowers but added confusion for others. First borrowers whose loans were financed in an old program called FFELP won’t receive the benefit. Because private investors hold the securities that finance their loans, the Department of Education can’t unilaterally modify the terms of the loan, even in a crisis. More than one-quarter of borrowers with outstanding debt have some of their loan balance financed in this way.
The second group of borrowers who may be left confused, or at least unserved, by this announcement today are the one-third of borrowers who are repaying their loans through income-based repayment plans. These borrowers are on-track to have their outstanding balances forgiven at the end of 20 years of on-time payments (10 years for workers in the public sector and non-profit employment.) They’re eligible for that benefit because they have relatively little income compared to the amount they’re on the hook to pay back. But despite being economically vulnerable, they have to keep making payments in order to maintain eligibility for their loans to be forgiven. Missing payments today won’t cause them to incur any fees or interest accumulation, but it will require them to, at the very least, postpone the huge benefit of loan forgiveness, they were slated to receive in the future.
The intention of these interventions is good. We need to be aggressive in delivering financial relief as quickly as possible. But there is a much easier way to provide relief that will prove more effective at getting help to those who need it: send cash and let borrowers continue to pay their loans.
Student loan are one of many financial obligations that are going to be troublesome for families in the coming months. But they are easier than most others to postpone. The federal student loan program has comprehensive safety nets built in to ensure that borrowers who face negative shocks to their income don’t have to make unaffordable payments. We should definitely put some resources into ramping up those programs right now. But we shouldn’t further confuse an already messy process by layering additional relief programs on top of them. For example, we need simplify the process of enrolling in income-driven repayment plans which ensure that monthly payments are affordable. We can do so by allowing online enrollment and eliminating cumbersome paperwork. We should also want to run information campaigns to ensure that that all borrowers know these benefits are available to them, not just the financially savvy ones. And most importantly, we need to make sure that none of these interventions leave borrowers worse off than where they started.
Instead, send cash now and prepare the existing safety nets to begin working overtime. We must replace the initial relief from cash transfers with targeted programs that deliver benefit only where it is needed. The income-driven repayment plans were designed to provide relief in times like these. Not to mention, student loans are likely to be held by many households who will not see a reduction in income since college educated workers are more apt to have jobs that can be done from home.
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