If President-elect Biden follows through on his promise to wipe out student loan debt, it will dramatically change the financial lives of more than 20 million Americans. It will also be a cornerstone of his economic legacy, and a political test for Republicans in 2022. But is this really the best course of action? Let’s take a look at the details. Let’s consider how much this decision will impact borrowers and the potential for inflation.
Biden’s plan to forgive up to $20,000 in student loan debt
President Biden’s plan to forgive up to $20k of student loan debt may sound like a dream come true, but many conservatives are skeptical of the plan. In fact, conservatives immediately denounced the plan as inequitable and fiscally irresponsible, claiming it will be unfair to millions of Americans. But some lawmakers are urging Biden to do more than just cancel student debt.
The plan has several different elements, including an income-driven repayment plan for borrowers who cannot pay their full balance. It would also cap the monthly repayment amount at 5% of borrowers’ income. But the proposal is still in the early stages, and it could take a year or longer to implement. Additionally, there is still uncertainty about the program’s fine print.
Although there’s some uncertainty regarding the timing of the program, the pause on payments on federal student loans is an excellent move. Since the pause was instituted at the beginning of the financial crisis, it has been extended at least five times. Earlier this year, the pause was scheduled to end at the end of the year. While the timing for debt relief is unclear, it’s worth noting that 45 million Americans owe over $1.6 trillion in federal student loans, more than any other consumer debt.
While the details of the Biden plan to forgive up to $20k in student loan debt are still being hammered out, borrowers can sign up for an alert system so they can be informed when the application process begins. The process can take up to two years to complete, and borrowers have until Dec. 31st 2023 to apply.
Warren’s plan to forgive $50,000 of debt
Elizabeth Warren’s proposal to forgive $50,000 of student loan debt is an unusual and ambitious policy proposal. This 2020 presidential candidate’s plan would eliminate the debt of about 36 million low-income Americans, making college free for those who can afford it. However, this plan relies on federal funding from the super-rich, which would mean that households with a net worth of more than $50 million would have to pay a wealth tax. Despite the enormous cost of the proposal, it is an appealing one for many Americans.
However, the amount of student debt that will be eliminated is still considerably higher than the amount of debt incurred by the average American student. The Institute for College Access and Success tracks the average student debt. It is not clear whether or not the new policy will make a difference in reducing student debt, but many advocates of student debt forgiveness are hopeful that it will encourage more people to finish college.
Warren’s proposal would give borrowers who owe federal loans the chance to avoid bankruptcy or to have the debt forgiven. It would cover about 80% of federal student loan borrowers, or approximately 36 million people. However, private student loans would not be affected by the plan.
The government has spent more than a trillion dollars on these programs since 2000. Nevertheless, the plan to forgive up to $50,000 of student debt would be a big help to those struggling with astronomical student debts. Moreover, this plan would be similar to what is currently spent on SSI, a cash assistance program that benefits 8 million people. The majority of SSI recipients have no other income, and about half have no assets at all.
Impact on borrowers’ financial decisions
A recent study found that student loans affect borrowers’ financial decisions in unexpected ways. For example, students from debt-friendly households and those from more conservative families may view student debt in very different ways. Likewise, students from low-income families may view student loans in a different light. Dynarski’s (2015) study found that student loans affected the financial decisions of borrowers in a variety of ways.
However, even those who are making timely payments reported negative financial outcomes. For instance, those with a small loan balance often experience increased risk of default, while those with large loan balances experienced fewer defaults. Whether borrowers are at risk for default depends on the amount of discretionary spending and their monthly payment amounts.
A high student loan balance may also discourage people from engaging in self-employment or entrepreneurship. These are risky endeavors, but they are important to development and economic growth. This is especially important for rural communities. By limiting the impact of student loans on borrowers’ financial decisions, it’s possible to reduce the risk of default.
Many of those struggling to pay back their loans reported that financial instability was their greatest obstacle to repayment. While most of them wanted to pay back their loans, they simply were not able to do so. In many cases, unexpected expenses caused ripple effects that affected their balance sheets. Because they had limited resources, they were forced to make trade-offs to meet their repayment obligations.
Increasing student debt levels is a major deterrent to homeownership, and it affects homeownership rates in both the short and long-term. A high student debt balance will also hinder borrowers’ ability to secure down payment and mortgage financing, which may discourage them from pursuing a mortgage. Further, many people with student debt do not want to take on more debt after college, so they turn to the rental market instead.
Potential for inflation
There are several concerns about the potential for inflation in student loans. Many lawmakers are calling for a moratorium on the repayment of student debt, which ends on May 1st. This move would cause the consumer price index (CPI) to rise by as much as 10 to 50 basis points or 0.1 to 0.5 percentage points, or from four to twenty percent. While the moratorium will allow students to pay off their debts with lower interest rates, inflation could result, and borrowers could see their payments rise even more than they expected.
While inflation can affect many industries, it has particular implications for the cost of student loans. For example, when the Fed increases interest rates, the yield on 10-year Treasury bonds goes up. This is the government’s way of paying back investors. Since 2013, student loan rates have been tied to the treasury bond rate. When the rate on the 10-year Treasury bond rises, the cost of a student loan increases by 2.05%. This is particularly harmful for borrowers who have variable-rate loans.
The Biden administration’s decision to cancel up to $20,000 of student loans is a relief to millions of borrowers. However, it has faced some criticism from economists who fear that the program will boost inflation. Conservatives have also decried the new policy. Mitch McConnell, a Republican, said that the plan would give more money to the elite who earn higher wages.
In the short term, the proposed student debt forgiveness plan is expected to raise inflation by only a small amount. This is because it would help borrowers spend their newfound money in the economy. The government has not yet determined how much this plan will increase inflation.
Impact on racial wealth gap
The impact of student loan debt is particularly devastating for Black and Latinx households. They typically borrow more money for college expenses than their white counterparts, and as a result hold lower wealth. It is estimated that if student loan debt was eliminated, Black households would have 40% more wealth. Currently, more than 40 million Americans are in debt for education. Of that, 25% are delinquent or in default.
The gap in wealth is especially significant among younger households. Whites, on average, have nearly 10 times more wealth than black households. Meanwhile, low-wealth black households have a negative net worth. On the other hand, low-wealth white households have a modest financial cushion.
The impact of student loans on the racial wealth gap is a complex phenomenon. Many factors contribute to this disparity. However, a higher education is more likely to lead to higher pay. Minority students are disproportionately affected by student loan debt. While college education should help Black Americans achieve financial success, it’s important to remember that student loans can prevent them from achieving homeownership.
Racial wealth gap persists despite the fact that most Black families don’t finish college. The majority of Black students begin college, but less than a quarter eventually completes a four-year degree. Consequently, black student borrowers are more likely to drop out and be left with a large debt, and they are also less likely to build wealth or labor market stability.
While expanding education opportunity is a priority for the United States, there is evidence that racial disparities exist at all levels. Racial disparities at all levels of education reflect and feed into each other. For example, the educational attainment of one’s parents predicts the educational level of their children.
