Yesterday, the Department of Education announced the following in response to the COVID-19 crisis:
- All federally held student loans will have interest rates set to 0% for a period of 60 days.
- Federal loan borrowers will have the option to suspend payments for at least two months — this is called administrative forbearance. To request forbearance, borrowers contact their loan servicer online or by phone.
- Secretary DeVos authorized an automatic suspension of payments for any borrower more than 31 days delinquent as of March 13, 2020, or who becomes more than 31 days delinquent in the next 60 days.
A Slightly Helpful Interest Waiver
The good news: the government is footing the bill for all interest on federal loans for 60 days. As we wrote about last week, this means the government is giving up roughly $13.39 billion in expected interest income to help borrowers.
The problem: this 60 day interest waiver has very little impact. Payments won’t change so there’s no immediate relief. If a borrower has outstanding interest, payments will be applied to that interest first then principal. If the borrower is on an income-driven plan, they end up owing a slightly smaller tax on the forgiven amount in the future (1 in 4 borrowers are in this camp).
The Waiver in Practice
We took an anonymized sample borrower from our system (let’s call her Alice) to determine what the impact of the waiver looks like in the real world.
Alice is four years into an income-driven plan (PAYE) paying $173 / month. Her AGI is $40k / year, she has $100k in outstanding principal and $30k in outstanding interest on her federal student debt.
At 6%, her monthly interest charge is $500. Normally, she pays $173 then the rest is added to her outstanding interest ($327). The government already pays $98 / month of that interest for Alice since some of her loans are subsidized.
With the waiver, the net benefit is $500 less the $98: $402 / month. With the 2 month waiver, that’s $804 off her forgiven amount, not her total cost.
To translate: $804 less will be forgiven down the line, meaning her estimated tax on that forgiven amount has decreased $281 — 16 years from now — assuming a 35% federal tax rate.
GREAT! The 60 day waiver saved her $281, 16 years from now.
That’s nothing in the short or long run. This change feels very immaterial for most borrowers despite the immediate income hit for the government.
Aren’t most borrowers on fixed payment plans though?
Nope, most are on income-driven plans, graduated repayment plans or not paying at all. According to the FSA data center, only 30% of borrowers are on fixed payment plans.
It’s unclear how servicers are going to process this change too — from what we can tell, the quickest way to implement the change is to treat all federally backed loans as subsidized in their system (a process that already exists).
Unclear Administrative Forbearance
Last week we discussed the benefits of having the US declared a “disaster area” and allowing borrowers to voluntarily enter natural disaster forbearance. In this scenario, borrowers could pause payments, no interest would accrue during the forbearance and most importantly no interest would capitalize at the end of the period.
These types of scenarios happen from time to time — for hurricane relief, tornadoes and even the California wildfires. Most importantly, servicers understand how to apply this type of forbearance automatically so a process is already in place to handle it.
What Secretary DeVos has authorized yesterday is similar to natural disaster forbearance, without the guarantee that interest won’t capitalize.
What’s the big deal with interest capitalizing?
Alice has $30k in outstanding interest. If she enters forbearance, her payments do not count towards forgiveness (meaning she has to wait 16 years and 2 months for forgiveness) and the $30k is added to her principal. Any future interest charges are based on $130k in principal instead of $100k.
For Alice, her annual interest charge would increase by $1,800 once the pandemic ends. Assuming a 3% increase in AGI and staying single, Alice entering administrative forbearance right now would increase her forgiven amount by $26,391 and total cost by $9,236.
This is financially devastating for many borrowers. If Alice elects for this forbearance right now, she’ll pay over $9k for it later. And that’s assuming that she re-enters her current plan in 60 days.
Makes that interest waiver seem even more frivolous, wouldn’t you say?
Suspending Payments for Delinquent Borrowers
Not much to see here. This just stops the bleeding — if you’re delinquent, you are already suspending your payment 😅
Who benefits from this response?
There are borrowers who will benefit from this type of forbearance. If you have an income that is significantly higher than your student debt principal and you are on the Standard or Extended fixed payment plan, pausing payments for a few months can help your cash flow. Since you don’t have outstanding interest, this forbearance gives you time to save your cash or spend on necessities instead of worrying about your loan payment.
The truth is that most borrowers are not in this scenario. Most are losing their jobs and need help navigating to an income-driven option while collecting unemployment.
Millions of borrowers are in need of guidance and these measures are not enough. We need voluntary natural disaster forbearance that counts paused periods as eligible for forgiveness — this one policy would cover all the bases and provide immediate relief for every single borrower.
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