What Might Be the Outcomes of a Student Loan Bailout?

Written by: Kristyn Pilgrim
Updated: 7/13/20

It’s either an idea whose time has come or one that’s too good to be true. Proposals for a full or partial bailout of $1.6 trillion in student debt were floated during the Democratic presidential primary.

Senator Bernie Sanders (I-VT) suggested giving all 45 million student borrowers complete forgiveness for their full federal and private student loan debt. For her part, Senator Elizabeth Warren (D-MA) had already introduced legislation to cancel student loan debt for more than 95% of borrowers and would cancel student loan debt for more than 75% of borrowers. Both relief schemes would depend on new taxes being levied.

When neither won the primary, the issue temporarily sunk beneath the fold and into the back pages. However, it was revived again in March 2020 with the arrival of the COVID-19 pandemic. It disrupted the economy and further eroded the ability of many borrowers to keep up monthly payments on their student loans.

The government’s response has put the idea of student loan relief again in the spotlight. Supporters of the idea say that borrowers relieved of their debt burden will give them more money, which they will plow into the economy, giving it a badly needed boost. Critics don’t like the idea of people getting out of debt this way, supported by taxes and government, and feel that it could have serious repercussions for the economy and people’s financial situations.

But whatever the solution, there is a growing acknowledgment that the problem must be dealt with. A 2020 study released by Moody’s Investors Service points out that the outstanding student loans of more than $1.6 trillion have more than doubled over the last decade and tripled since 2006.

Of the individuals who took out student loans from 2010 to 2012, only 51% have made any progress toward paying them down. At 11%, the default rate for student loans is the highest for any debt category.  One reason that student debt levels aren’t going down is that many people are taking advantage of repayment plans based on income, along with some opting for longer repayment options. 

Different Approaches to Emergency Student Debt Relief

The Trump administration announced in March that it would freeze student loan interest as part of its response to the coronavirus emergency. The freeze on interest accrual would be temporary but go on for as long as the policy was unchanged. However, it would only apply to student loans held by the federal government and not private ones.

Later in the month, a Senate coronavirus stimulus bill passed, allowing student loan borrowers to put off paying their federal student loan payments without penalty through Sept. 30, 2020. The bill also suspends the collection of defaulted debts, including wage and tax refund garnishment.

The bill, as well, helps those in the Public Service Loan Forgiveness (PSLF) program, stipulating they will not be penalized for missing payments over the next six months, so borrowers in the public service can still see their student debt wiped away after 10 years.

In May, the U.S. House of Representatives passed the HEROES Act, a $3 trillion stimulus bill, which would include additional relief for those with student loan debt.

It would provide $10,000 in federal student loan forgiveness for borrowers who are in default, are delinquent, or have deferred loans due to economic hardship. Private student borrowers can also receive up to $10,000 in loan forgiveness under some conditions. The Act provisions would also see an extension of the suspension of payments and interest on government-held federal student loans until September of 2021.

To satisfy objections to the bill in the Republican-controlled Senate, the act includes an amendment for borrowers of private student loans. People can only qualify if they meet one of the following criteria:

  • They are “economically distressed.”
  • They are in default with a private loan.
  • They are delinquent in payment (90 days past due).
  • They have private student loans in forbearance or deferment for financial or other reasons.

As well, a private student loan borrower who had a federal student loan would have a monthly payment of $0 through an income-contingent repayment plan (ICR) or income-based repayment plan (IBR).

However, even with the amendment, Republican senators have let it be known they are unlikely to pass the bill in its current form.

Benefits of a Student Loan Bailout

Democrats, such as Sanders and Warren, believe that a substantial student debt bailout can:

  • Reduce the wealth gap
  • Provide an economic stimulus for the middle class
  • Encourage the start-up of small businesses
  • Increase homeownership
  • Enable young people to start families without the burden of debt hanging over them

Their reasoning is supported in part by a working paper distributed by the National Bureau of Economic Research. Looking at 10,000 borrowers who had their private student loans canceled, the paper found they were more likely than similar borrowers to move, change jobs, or go back to school. The group also saw their incomes increase by $4,000 over three years, on average.

As well, these borrowers were less likely to use other forms of credit — which would reduce their indebtedness by 25% — and they were 12% less likely to default on those accounts.

Another study, released in 2018, suggests that “policies like student debt cancellation can be a viable part of a needed reorientation of US higher education policy,” helping to boost the GDP and decrease unemployment. 

Drawbacks of a Student Loan Bailout

Critics of this approach point out that rather than reducing the wealth gap, it might widen it. People with the largest student loans are the ones who use them for graduate studies and usually don’t have trouble paying them back because of their higher salaries.

Those who default on their loans have, on average, under $10,000 in student loan debt. These people tend to be low-income, minorities, former students of for-profit institutions, and those who dropped out of school before getting a degree.

Wiping out student loan debt would benefit people with more money and create more economic distance from poorer families.

Other problems could include:

  • Lost revenue: Because about 90% of student loan debt comes from the federal government, forgiveness could mean a loss of about $85 billion, or 0.4% of GDP, in forfeited student loan principal, interest, and fees.
  • A growing amount of student debt: Knowing their student debt is likely to get canceled, more people might apply for loans.
  • A future economic crisis: If more people take student loans expecting forgiveness, and this doesn’t happen, then the country could face an even bigger default crisis.
  • Rising tuition costs: Already expensive colleges would have no incentive to try to keep prices down in a scenario where student loans are easy to get and get rid of.

Those who love small government also point out that taxing the rich to pay for the student loan bailout could backfire. The rich usually have the means to find ways to minimize their tax burden, which means the cost of financing the student loan tax cuts could fall on the overburdened shoulders of the middle class.

Finding Better Ways to Finance a College Education 

With the ongoing national dialog about student loan debt and how to manage it, it has become more important than ever to make wise financial decisions when it comes to receiving a higher education. With the right tools and information, it is possible to keep the economic burden manageable and enable the student to concentrate on their studies and their future, rather than worrying about a lifetime of debt.

CollegeFinance.com provides an ever-growing hub of resources that give you the intelligence to make informed decisions about going to college.