Why Student Loan Forgiveness Won’t Help Most Borrowers in the Long Run

Student loan forgiveness is one of the more popular political topics in our current environment.

On the surface, student loan forgiveness sounds like a good idea. Unfortunately, many millennials and Gen-Z are held back by the weight of student loans. For example, large student loan payments can keep a family from buying a home instead of renting, taking a nice vacation, etc.

I know there is a case where student loans can provide significant benefits at the micro-level to specific families. However, it would be a disservice not to explore the impact of student loan forgiveness at the macro level.

The longer-term macro impacts will also impact families that benefit from student loan forgiveness at the micro level. For example, it might help in the short term to never have to worry about paying your $400 per month student loan, but what good is it if you have to pay $400 more in rent or a mortgage in a few years because of inflationary pressures?

The easy thing to say is to wipe out student loans and free people from the burden of their payments. Please know that I understand the difference this could make in many people’s lives. However, with anything like this, there are second and third-level impacts. This post will explore the downstream effects of student loans and the alternatives to student loan forgiveness that may be better in the long run.

The Student Loan Landscape

Student loan forgiveness releases borrowers from the obligation to repay part or all of their federal student loan debt.

The second-largest debt in the United States is student loan debt, behind mortgage debt. As of 2021, student loan debt totaled $1.75 trillion, increasing nearly six times faster than the nation’s economy.  There is no sign of a slowdown in sight. Total student loan debt has more than doubled since 2008

A college education is still the best way to middle to upper-middle-class life. Colleges know this as well, which is why tuition increases every year. Colleges are also competing with other schools around the country, resulting in more money spent on new buildings and athletic facilities to keep up.

Student loan debt has grown faster than any other household debt over the past decade. As a result, students are burdened with more student loan debt than ever. Student loans can create huge debt burdens for individuals after college, especially those who accumulate debt but don’t get a college degree.

Does Student Loan Forgiveness Help Those Really in Need?

If student loan forgiveness were to happen, this begs the question of who would benefit the most.  The answer is those in the upper half of the income distribution and those with graduate degrees. The lowest-income 40 percent of households hold just under 20 percent of outstanding student loan debt and only make 10 percent of the payments.

I question if those in the upper half of the income distribution need this kind of relief. Millions of Americans live in poverty, most of whom do not have any student loan debt. Wouldn’t focusing our tax dollars on helping those people be better? The college graduate with an excellent corporate job doesn’t have nearly the same benefit from a $300 monthly payment reduction as providing $300 to a family that can’t even put food on the table.

Do the Short-term Benefits Exceed the Long-term Consequences?

The short-term benefits of student loan forgiveness are clear; it releases borrowers from the burden of having to repay loans for college. In addition, student loan forgiveness would provide young borrowers with money to buy their first home or new car. In turn, these things stimulate the economy.

Eliminating a monthly $300 student loan payment would temporarily relieve millions of Americans. However, what if, in turn, resulted in even higher inflation in an already overheating economy?

When inflation goes up, so do interest rates. For example, a one percent increase in mortgage rates on a $300,000 mortgage would increase the monthly payment by nearly $200. So while student loan forgiveness does not directly lead to higher inflation and interest rates, it could contribute.

Student Loan Forgiveness Does Not Fix the Underlying Problem

Let’s pretend for a minute that all federal student loans are forgiven.

Do we go right back to issuing student loans to new borrowers?

Student loan forgiveness feels short-sighted for many reasons. What incentive will colleges have to reduce tuition costs by combining student loan forgiveness with reform? Colleges would likely raise tuition even more because of the sense of security borrowers may have that student loans may be forgiven again.

The root of the issue is that college has become unaffordable for many families. Yet, an 18-year-old can sign up for tens of thousands in student loans without knowing what they are doing. Student loans are an issue for many individuals and families. However, the more significant problem is how tuition has grown over the past two decades.

The bottom line is that reform is needed in the student loan program and college education in general, and canceling student loans doesn’t do much to fix these issues. If anything, it potentially worsens for the next generation of borrowers.

The Economy is Already Overheating

Since the pandemic, the pause on student loan payments has likely contributed to an overheating economy. The pause on student loan payments has served as a stimulus, which wasn’t necessarily bad early on in the pandemic. Many people were out of work, and sectors of the economy were struggling.

Inflation is currently at the highest level in decades, the job market is at an almost unhealthy low unemployment rate, and the housing market has been out of control over the past 18 months. Additionally, the federal government is already trillions of dollars in debt, with the national debt increasing significantly with recent stimulus in response to the pandemic.

What good is saving a few hundred dollars a month on student loans when collectively, your expenses go up by a few hundred dollars in a year or two anyway? Of course, student loan forgiveness isn’t the only factor contributing to current inflationary pressures. However, it is part of the equation.

The Alternatives to Student Loan Forgiveness

Even though I don’t believe that waving the magic wand and forgiving federal student loans is the best approach, I think reform is needed. Both with colleges and the continually increasing rises in tuition, and to help those struggling with student loan debt. Below are a few places to focus on instead of broad student loan forgiveness.

Improve Income-Based Repayment Plan Programs

Income-based repayment plans allow borrowers to repay student loans based on a percentage of an individual’s discretionary income. The cap is set at 10 percent of discretionary income for most plans. Depending on the program, the borrower’s payments are capped at 10 percent of discretionary income for 20 to 25 years. Then, the remaining balance on loans is forgiven at the end of that period.

Income-based repayment plans sound great on paper. However, recent reports have provided evidence that income-based repayment plan programs have been poorly managed. There is significant bureaucracy up front, but there have been many reported cases where the Department of Education lost track of important information about an individual’s plan.

The good news is that there has been political pressure to improve these programs. For example, the FUTURE act will improve data sharing between the IRS and Federal Student Aid (FSA) programs. Additionally, the Department of Education recently announced actions to fix longstanding failures in student loan programs. These are all steps in the right direction.

If these programs run effectively, low-income borrowers should not face overwhelming monthly student loan payments. So let’s start with putting resources towards fixing these programs so that those struggling to make their student loan payments can get a break.

Allow Student Loans to Be Discharged in Bankruptcy

Federal student loans are easy to get partially because they cannot be forgiven in bankruptcy. Not discharging student loans in bankruptcy means lenders are willing to give out more money at a lower interest rate as borrowers are more likely to repay the loan.

Allowing student loans to be discharged in bankruptcy is a double-edged sword. Since student loans are not allowed to be discharged, lenders are more willing to offer student loans. This makes getting a college education more accessible to individuals that may not otherwise qualify for loans.

At the same time, allowing student loans to be discharged would force lenders to consider how they are lending money more carefully. But, again, this is a tough one because many high-risk borrowers who are not qualified at the time go on to get college degrees and can pay back student loans.

Without access to that money, they may never have been able to attend college. However, loaning that money is a disservice to some because they don’t know what they’re getting into and are burdened with debt they may never be able to repay.

Regardless, if we are serious about helping fix the student loan crisis, allowing student loans to be discharged in bankruptcy should be an option.

Forgiveness for the Low Income Population or Public Service

If we go the route of student loan forgiveness, let’s consider doing it for the small percentage of loan holders who most likely need assistance. As noted earlier, most student loan borrowers are degree holders in the country’s top half of income earners. Yet, only 20 percent of loans and 10 percent of payments are made by individuals in the lowest 40 percent of households.

Could someone much more intelligent than I come up with a process to forgive loans for those under a certain income threshold or those who never end up with a college degree? I know this is easier said than done, but there has to be a solution to help people most in need. Even though many lower-income earners have income-based repayment plans, allowing forgiveness would remove a huge burden from their lives.

There are also programs to forgive student loans for public service after several years. Let’s explore options to reduce bureaucracy and expand the program to other professions. If someone spends ten years using their degree providing public service, they should be eligible for student loan forgiveness.

Summary: Why Student Loan Forgiveness is a Bad Idea

With anything in life, there are tradeoffs. There are undoubtedly short-term benefits to student loan forgiveness for everyone. Less money paid to student loans allows more money to be spent on new homes, cars, vacations, etc. These things are all good for the economy. They create jobs, enable families to move into nicer homes, and more.

The two overarching questions in this post are 1) Are we helping the right people? 2) With the economy overheating, is this the right time to consider student loan forgiveness?

I’d argue that the answer to both of these questions is no.

Tens of millions of people live in poverty in the United States. People who struggle to put food on the table or afford necessities. The majority of these people are not student loan holders. It feels like we have a blank checkbook within the federal government, but tradeoffs still need to be considered. Student loan forgiveness doesn’t seem like it should be a top priority.

Inflation remains high, the unemployment rate is at an almost unhealthy low level, and housing prices have increased significantly over the past few years. So why throw gasoline onto the fire? Even though student loan payments have been delayed for a couple of years, knowing that borrowers will never have to repay their loans will stimulate the economy even more when it doesn’t need to be stimulated. Eliminating student loans also changes a borrower’s debt-to-income ratio, and many would be eligible to qualify for additional loans.

Again, what good is allowing a few hundred dollars of student loan debt to be forgiven if it results in even higher inflation that increases the cost of goods in all other areas?

That said, there are pockets where student loan forgiveness makes sense. For example, forgiveness makes sense when individuals have several years of public service, have been paying into income-based repayment plans, or are in the low-income population. But first, let’s focus on these areas before waving the magic wand and forgiving federal student loans for everyone. The consequences of doing this could far exceed the potential benefits.