Student Loan Debt Cancelation

9/26/2022 - By Chris Stennett, CFP®

On August 24, 2022, President Joe Biden announced his administration’s plan to reduce student loan debt for millions of Americans. The plan consists of three parts: Targeted debt repayment relief, improving the loan system for current and future borrowers and reducing the cost of college by holding schools accountable for rate hikes. While all three parts are relevant, I am going to focus on targeted debt repayment relief – or said more clearly: Student Loan Debt Cancelation.

With this announcement, borrowers will be given a one-time payment (discussed below) to reduce their outstanding student loan debt. While the details of this program are still being discussed, here’s what we know so far:

Who is eligible?

“Any individual borrower with an Adjusted Gross Income of $125,000, or $250,000 for Married Filing Jointly or Head of Household filers, in either 2020 or 2021 will be eligible. Your Adjusted Gross Income is the income that is taxable, after qualified adjustments or deductions, and can be found on IRS Form 1040, Line 11,” according to Michael Cole, JD, MSPA, Director of Tax & Accounting for Saltmarsh, Cleaveland, and Gund.

The outstanding loan types available to receive the debt payment are most Federal Student Loans. This includes undergraduate and graduate Stafford Direct Loans, Parent PLUS, Grad PLUS and consolidation loans (if the consolidated loans were disbursed on or prior to June 30, 2022). Additionally, some Federal Family Education Loans and Perkins Loans held by the Department of Education are eligible. The same goes for defaulted loans controlled by Education Direct, including commercially serviced Subsidized or Unsubsidized Stafford Loans. Non-federal private student loans are not eligible for debt forgiveness, including any federal loans consolidated into private loans.

Amount to be Canceled

The amount to be canceled depends on the loan type that was issued. For Pell Grant recipients, up to $20,000 in debt cancelation will be provided. For non-Pell Grant recipients that amount drops to $10,000 in debt cancelation. To check for the type of loan/grant, visit www.studentaid.gov.

You will only receive up to what your outstanding loan balance is. If you qualify for $10,000 in debt cancelation but only have $7,000 outstanding in student loans, expect to receive $7,000. Borrowers who continued to repay their student loans during the pandemic-related payment pause are entitled to receive a rebate so they can maximize their forgiveness eligibility. While this only applies to a small percentage of borrowers, this refund of premiums paid could be repurposed in that individual’s life and still have their student loan debt reduced or eliminated with the federal payment.

How will this be funded?

According to an estimate by the Wharton Budget Model, the plan to cancel student loans will cost up to $519 billion over the next decade. While the White House points to recent deficit reduction as a means to pay for the programs, the US has run on a deficit since 2001 and will either need to make cuts to spending or increase tax revenue in the future to curb the rising risk of debt default. In either case, with low corporate taxes, it’s ultimately the general public who covers the cost.

How will this help?

Approximately one out of every seven Americans has student loan debt, with an average amount owed per borrower of almost $29,000. So how does a $10,000 cancellation help? When you examine the default data, borrowers who default typically do so with loan amounts between $2,000 and $10,000. Why? Generally, students who borrow large amounts attend graduate/advanced degree programs. With these degrees comes an increased earning potential, allowing the borrowers to eventually earn enough to repay the debt. Conversely, students with smaller balances generally attend community colleges or drop out of university. This added debt, with arguably a limited earning potential, makes repayment very difficult. Eliminating outstanding student loan debt for these borrowers theoretically allows for those future monthly payments to be repurposed to better their financial position.

Even if that can’t be promised, simply avoiding default for these borrowers creates a net positive for society. With debt cancelation, these individuals will see a rise in credit scores, increasing their potential for home ownership and reducing the interest costs on loans. With a more secure financial footing, these borrowers can begin to pursue their passions and will have easier access to financing capital when innovation strikes. Without debt cancelation, an argument could be made that these individuals would need some other form of social financial assistance further down the road. That’s because defaults and extended repayments reduce a borrower’s capital and creditworthiness limiting access to financing for basic purchases - let alone entrepreneurial endeavors. They also increase the overall cost of borrowing (higher interest rates), assuming they are even approved in the first place.

To Apply

A form will be launched in October to apply for the benefit, which you’ll access either from your loan service provider or the Student Aid website I mentioned earlier. Also, review your borrowing history on the student aid website. If you would like a refund of payments made, contact your loan service provider to discuss their processes.

One important note Mike Cole wanted to make clear is, “While it is highly unlikely that these payments will be taxed at the federal level, there is some discussion that they could be taxed at the state level. You should absolutely consult a tax professional about the implications of receiving the federal funds if you live in a state where taxes could be levied.”

If you have any questions about the Student Load Debt Cancelation, don't hesitate to reach out to our Saltmarsh Financial Advisors.

About the Author | Chris Stennett, CFP®

Chris is a senior financial advisor and Certified Financial Planner® practitioner for Saltmarsh Financial Advisors, LLC, an affiliate of Saltmarsh, Cleaveland & Gund. He serves individuals and organizations as a comprehensive financial planner and coordinator of investment activities. His areas of expertise include investment management, income planning, tax and estate planning and risk management. Chris has over a decade of experience as a wealth manager working with teachers, federal and state employees, retired Armed Forces and private-sector employees.