Student loan forgiveness? It’s more complicated than you may think.

12.01.21 08:00 AM Comment(s)

From the Clipboard - Student loan forgiveness? It’s more complicated than you may think.

Student loan forgiveness would be nice to have but probably shouldn't count on it. Kind of like winning the lottery but it doesn't happen often. There are a number of issues that have to get resolved before the Biden administration would be able to do this even though some have argued that President(-elect as of this writing) Biden could do it just by executive order.

Now, for me personally, I still have a Parent PLUS loan for my son’s college. If my loan is forgiven, I would be really happy because that would help me, but i'm not counting on it.

There are already existing programs for forgiveness. For example, the Public Service Loan Forgiveness (PSLF) program would be available to those who worked in the public or non-profit sectors for 10 years. Their loans can get forgiven, subject to some additional conditions, and be income tax free under current regulations.

Teachers who teach in public schools in low income areas may qualify for partial forgiveness under the teacher loan forgiveness program, subject to certain qualifications.

There's also special considerations for those in the military and veterans, as well as discharge for death and disability.

However, there’s been discussion in the news about other loan forgiveness programs. With the incoming administration, numbers have been proposed of potentially $10,000, $50,000 or total debt forgiveness (totals $1.5 trillion).

Personally, I don't think additional loan forgiveness is going to happen.

First, there's an issue of fairness. By forgiving student loans, the government is essentially transferring that burden to all taxpayers though not all taxpayers attended college; only 35% of people under age 25 had an undergraduate degree. Should the people who didn't go to college bear a tax burden to help pay off loans for those who did attend college?

The idea of student loan forgiveness is actually pretty popular even among those who went to college.

Second, forgiveness can create a disincentive. How would it be viewed by people who really worked hard or worked second jobs or extra shifts to earn extra money to pay off their loans? Would there still be incentive for people to work really hard to save for their kid’s college so the family doesn’t have to borrow for college?

And for myself, who took a Parent PLUS loan to help my son, there's really been no discussion in any of the proposals about forgiving  Parent PLUS loans. (I’m not complaining that I did this, but there are parents who do take out a large amount of debt - they may not be so happy!)

Third, the Bennett hypothesis. In the late 80s, during the Ronald Reagan administration, William J. Bennett was the Secretary of Education. He put forth this idea that if the federal government offers more student aid, the extra aid would not really help families afford college because colleges would simply raise the price.

For example, if loan forgiveness is $10,000 per year, over time colleges would raise the price by an extra $10,000. Studies have been done that both support as well as refute the hypothesis.

Personally, I suspect that over time, the hypothesis is true. The point is that if you knew taking on student loan debt, and that $10k would be forgiven, would you now set your sights higher by $10k? Would a family that was willing to borrow $40k previously, now look to borrow $50k and thus lead to a higher price for college?

Fourth, potential tax impact of loan forgiveness. In the existing programs like PSLF and teacher, as well as discharges for death and disability, the transaction is tax free.

Generally speaking, with any other type of loan forgiveness, the forgiven amount is treated as taxable income. There’s been little discussion on how any new program would be considered for tax purposes.

Thus, while loan forgiveness may be a great idea on paper, and just a stroke of a pen to make debt disappear, it is really, really complicated. As a result, as the saying goes, don't hold your breath.

It's still up to each family to borrow and manage their finances responsibly. Families who are in the search process still need to do a thorough search so that whatever school your son or daughter attends, the school fits financially as well as academically, socially, and culturally.

I've had people already ask me whether or not they should send their student to a school knowing they will have to borrow, but with the expectation that part or all of the loans would be forgiven. I would not suggest that.

This is a big issue being discussed. Let me know your thoughts on this. I would love to hear your position on loan forgiveness and the questions that you may have.

I write primarily on college financial aid and retirement planning topics. My firm has a particular specialty in working with self-employed or small business owners on these issues. 


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