Finally, we've received clarity on student loan forgiveness and repayment. Here's what investors need to know.
September 18, 2022
Finally, we have some much-needed clarity on student loans.
Three weeks ago, the Biden Administration and the U.S. Department of Education announced a three-part plan designed to “help working and middle-class federal student loan borrowers transition back to regular payment as pandemic-related support expires.” The move came more than two years after payments on federal student loans were initially paused at the start of the COVID-19 pandemic. The plan includes a combination of one more extension to that pause, targeted student loan forgiveness that will apply to most borrowers, and several changes to make the existing student loan system more manageable for current and future borrowers.
Of course, 7investing is an site that focuses on investing in individual equity securities. So — noting I’ve covered the topic previously and with the application for forgiveness expected to be made available in the coming weeks — how does this affect our thinking?
Here are five things investors need to know:
First, some foundational figures to lay the groundwork: The U.S. department of Education will cancel federal student loan debt of up to $20,000 for borrowers who received a Pell Grant in college — 94% of whom come from families with incomes of $60,000 or less — and up to $10,000 for non-Pell Grant recipients. As suggested by then-White House Press Secretary Jen Psaki in May, student loan forgiveness will only apply to individuals with annual income of less than $125,000, or households with annual income of less than $250,000. According to the Administration, this collectively means around 87% of debt cancellation benefits will go to borrowers earnings less than $75,000 per year.
Finally, it’s important to note forgiveness is limited to federal student loans held by the U.S. Department of Education — so it does not apply to private student loans or federal student loans that have already been refinanced with a private lender.
Noting repayment was previously set to resume at the end of August 2022, the Biden Administration extended the student loan repayment pause one last time through December 31, 2022. This marked the 7th extension since the pandemic began (including two extensions of the initial 6-month pause under the Trump Administration, and now five from the Biden Admin).
To be clear, this was the final extension, and payments will resume in January 2023 for any unforgiven federal student loan balances.
On the heels of last month’s slightly hotter-than-expected Consumer Price Index (CPI) report — which sent broader stock market indexes plunging after pegging year-over-year inflation in August at roughly 8.3% (cooling from 8.5% in July but missing estimates for 8.1%) — one of the biggest concerns for investors is whether student loan forgiveness will exacerbate the problem of inflation.
The short answer? Yes and no.
Roosevelt Institute economists Miek Konczal and Alí Bustamante have argued that any impact to inflation of student loan forgiveness in the near term would be “small” and more than offset by the resumption of student loan repayments next year. Their sentiment was echoed by Moody’s Analytics chief economist Mark Zandi, who estimates the CPI reading would indeed increase by roughly 0.08% (assuming Biden’s student loan forgiveness plan moves forward without a hitch) only to decline by 0.11% after the repayment pause ends — ultimately making the net effect on inflation of Biden’s plan “largely a wash.”
Nonetheless, the forgiveness aspect of the plan could still be challenged in the courts. On the heels of the announcement last month, conservative attorneys general from Arizona, Missouri, and Texas were already reportedly weighing options to bring legal challenges to the Biden Administration’s plan for student loan forgiveness, arguing the move to “unilaterally dismiss debt or transfer wealth from one group to another group” would be illegal and a “huge power grab.”
Meanwhile, vocal critic Senator Ted Cruz argued the plan primarily benefits people like “that slacker barista who wasted seven years in college studying completely useless things,” and went on to suggest it was little more than an effort by Democrats to bolster their standings in the upcoming midterm elections. However, Cruz also subsequently acknowledged it “may prove a real challenge” to fight the plan in court.
Even so, we should keep in mind that any legal challenges to student loan forgiveness likely wouldn’t impact the other two parts of the Biden Administration’s three-part plan; payments will almost certainly resume in January 2023 and changes to make the existing student loan system more manageable and navigable would be implemented regardless.
Finally, to be clear, this clarity on student loan forgiveness and repayment is a good thing for student loan servicers and refinancers — many of which have worked to accelerate diversification efforts over the last couple of years during the pause and are set to emerge as stronger businesses. I recall I wrote in May that cancelling $10,000 in debt per borrower would eliminate around $321 billion of federal student loans assuming no income limits. But now, assuming 75% of eligible Americans with federal student loan debt participate, the White House estimates the plan will cost around $240 billion over the next decade. That’s still a reasonably small slice of the current $1.7 trillion total in federal student loan balances. So while the overall addressable market for refinancing and servicing will be smaller, this will serve as a spur for borrowers to finally refinance the balance of their loans as interest rates continue to climb.
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