Implicit Student Loan Forgiveness

December 25, 2021April 29, 2022 ryan.renkey inflation

This week President Biden announced that payments on federal student loan debt will continue to be suspended through May 1st of 2022. While this is a suspension rather than an outright cancellation of debt, for some borrowers it might almost be as good as the student loan forgiveness proposals from the 2020 election campaign cycle.

Welcome news for public sector employees

While all student loan holders’ benefit from the suspension of payments, borrowers who qualify for public service loan forgiveness stand to benefit the most. This is because their time working will count towards the 10 years of required payments even though no payments are required!

“The relief is even more significant for those who work in the public sector and may be eligible for federal student loan forgiveness after 10 years. They are still receiving credit toward those 10 years of required payments as if they had continued to make them during the pandemic, as long as they are still working full time for qualifying employers.”
Katie Lobosco, CNN in Biden extends pause on student loan repayment through May 1 – CNNPolitics

This means these borrowers will never have to make the monthly payments from the 26-month period from March 2020 to May 2022. For the average bachelor’s degree holder with debt the savings can be significant. Given an average debt of $28,950¹ the current rate for undergraduate loans of 3.73%², and a standard loan term of 10 years, we can calculate a typical monthly loan payment of $290. The total of pandemic related expenses that will never need to be repaid is the product of the number of months and the monthly payment or just over $7500.

What about private sector employees?

Borrowers who work in the private sector still benefit albeit maybe in ways that are less obvious. The benefit comes by spending money that would have gone to loan repayment on things such as:

Pay down debt. Since student loan debt is currently at 0%, all other debt is higher interest debt
Contribute more to retirement accounts like IRAs earlier in the year to benefit from more time in market
Earn money by investing in low-risk government bonds like I-Bonds which currently earn a risk-free rate of 7.12%

Additionally, borrowers benefit from recent inflation. While it’s true that inflation stretches your wallet as prices increase, the price increases don’t affect past purchases. Even as prices for current goods and services increase, the dollar value of debt remains the same. Since we can expect wages to increase with the overall pace of inflation, we can conclude that we’ll have more future dollars to pay back our debts.

I’m not following, how about an example?

Let’s say you have a $10,000 loan, make $100,000 a year, and a house is worth $500,000. In this world, the inflation rate jumps from near zero to 10% over the next year and because the government paused payments on your loan you still have the same $10,000 loan. However, even though the loan is the same, your salary is not. Your salary has increased by the rate of inflation and now stands at $110,000. The same house that was $500,000 remains exactly 5x your salary at a new value of $550,000.

In this example, inflation increases salaries as well as the cost of goods and services. With the same salary you can buy the same amount of clothes, diapers, houses, and other goods but your debt remains unchanged. Any debt payments that you make will represent a smaller fraction of your overall income after the wage and price increase. This logic works for all holders of fixed interest debt in an inflationary environment.