How student loan forgiveness will impact the markets
Student loan forgiveness has been a hot topic in the news over the past several months. That's because U.S. President Joe Biden recently unveiled a plan to forgive a large amount of student loan debt for millions of Americans.
This could put a lot of spending money into the pockets of many student loan borrowers. It's only a matter of time before that money works its way back into the economy, buoying private businesses and improving the stock market.
That's a big question. And to answer that, we have to dive into an even bigger topic. But that's what I love about it.
Let's start by backing up a bit and asking a different question: "Why is forgiving student loan debt important?"
The student loan problem
Higher education costs are widely debated in the United States. Those who support forgiving student loan debt often cite the effects these loans can have on borrowers. In order to afford college, many students need to borrow tens of thousands of dollars (or more!). This often leads to a choice between forgoing a formal education or spending decades in debt in order to pay for one.
This can create a domino effect that first affects a person's career options, then their potential income, their housing, and family life. Or, they could choose to be in debt for decades. Whichever decision they make, their financial security is at stake. It's a potential spreading stain of effects rooted in the first decision most of us make as adults.
This decision becomes increasingly difficult as college costs balloon from year to year—and with it, student loan debt. Within the past ten years, total student loan debt has risen by nearly 75%. In 2012, outstanding student debt totaled $948.2 billion. That already-staggering amount has risen to over $1.6 trillion in 2022.
Currently, the average student debt an individual might owe is roughly $30,000. That kind of debt can make affording life more difficult. And, as I've said, paying it off can take decades.
Over the past several years, many politicians have taken sides in this debate. Some argued for free education. Some argued for complete student debt forgiveness. Either way, it was clear: some sort of solution was necessary.
Enter student loan forgiveness
When Joe Biden ran for President in 2020, he included student loan forgiveness in his platform. Instead of total forgiveness, he promised to forgive $10,000 worth of debt for student loan borrowers. The goal was twofold: it would ease the financial stress of the average American, which would provide them with more spending money they could put back into the economy.
In August 2022, Biden finally announced his student loan forgiveness plan. The government would forgive $10,000 in federal student debt for individuals who make less than $125,000 per year ($250,000/yr for married couples and heads of household). This amount increased to $20,000 for those who received Pell grants, a needs-based form of federal student aid.
The plan affects over 43 million borrowers. 90% of all student loan borrowers can qualify for some amount of debt relief. Nearly 30% of those who receive student loan forgiveness will see their debt completely wiped out. The other 70% should see their loan balances decrease enough to lower their monthly payments.
In total, the plan forgives about $500 billion in debt for all student loan borrowers.
Which loans are forgiven?
This is a good distinction to make. Biden's plan only forgives a form of federal student aid referred to as "direct" loans—loans provided by the government, then typically assigned to a loan servicer. The plan doesn't forgive Federal Family Education Loans (FFEL). FFEL loans are provided by private companies, such as banks, but are backed by the federal government. Though the FFEL program ended in 2010, many recipients still owe money on their loans.
When the plan was first announced, FFEL recipients had the option of consolidating their loans with direct loans in order to qualify for debt forgiveness. However, the Department of Education later announced that this was no longer an option. Please take this into account before deciding to consolidate, as doing so could also increase interest rates on your loan. As always, we recommend consulting a financial advisor before making this kind of decision.
How does forgiven student debt affect the market?
To be truthful, we can only guess. But we know that the primary effect will be more Americans with lower bills, and thus an increased amount of spending money. Biden's plan also calls for lowering the payments for those on an income-driven repayment plan, capping payments at 5% of their income rather than the previous 10%.
All told, that's a lot of money to go around. But what does that mean for the market?
For that, let's first look at what that might mean for the economy:
Increased savings with PSLF
The Public Service Loan Forgiveness (PSLF) plan forgives direct loans for those working in public service. Usually, one qualifies for PSLF by making 120 qualifying payments under a qualifying plan. This is a great benefit on its own. Even better are new rules for the PSLF from the White House.
Under the student loan forgiveness program, recipients can apply for credits for previous payments they've made that hadn't qualified for PSLF at the time. There is an online application process for limited PSLF waivers. The deadline for completing the application to receive these additional benefits is October 31, 2022.
A large number of those receiving student loan forgiveness are young adults. This also happens to be the same audience targeted by investment apps, such as Robinhood and Coinbase. Apps such as these help users invest any amount of money (no matter how small) into the stock market. There's a good chance we'll see an increase in borrowers using their extra cash to become investors.
As meme stocks and FOMO investing have increased in popularity over the last few years, it's also likely that we'll see an uptick in these investments, as well.
Increased holiday spending
Those that apply for student loan forgiveness should see their loan forgiven within a few weeks. For applications submitted on time, can put extra money in people's pockets by the end of the year. This can help increase their ability to spend when preparing for the holidays.
This is a crucial time of year for the economy, with holiday spending accounting for 30% of some retailers' annual revenue.
Does this help the market?
Experts are unsure whether these benefits will actually have a big impact on the stock market. There are two primary reasons for this:
Money over time
Though the student loan forgiveness plan can decrease some peoples' debt by up to $20,000, they don't receive a check for that amount. Instead, their savings come as lower bills spread over years—even decades. While this can lead to increased spending money, it's unlikely to lead to large amounts of money all at once. Instead, it's more likely that this money will help pay other bills or increase small "fun" purchases throughout the year.
Student debt payment pause
In 2020, the government enacted an optional pause for student loan repayment. This was done to help ease Americans' financial burden during the pandemic. The end date for this pause keeps getting pushed back further and further. As yet, the pause has not ended.
Just recently, the pause got pushed back once more. The new end date for the pause is December 31, 2022. This means that many borrowers won't see lower bills until the new year. And, since these are bills they aren't currently paying (and haven't in two years), it might actually somewhat increase their financial burden from where it stands right now—even if they come back lower.
Will student loan forgiveness affect inflation?
At the end of the day, interest rates are the current concern of the stock market. And that's a decision only the Federal Reserve gets to make. Because interest rates have a direct effect on stock prices, the Fed's decisions are likely to have a much bigger impact on the stock market than student loan forgiveness.
And those decisions could be affected by inflation.
The inflation problem
Some critics of the student loan forgiveness program worry it could actually increase inflation (already a concern for retirement savers). But let’s consider two ways people have received financial relief during the pandemic.
With stimulus checks, Americans received money in large, lump sums. For some, this went towards big-ticket purchases, such as TVs and other electronic devices. For many, this money helped pay for bills, food, and other necessities. Either way, this money came all at once and almost immediately returned to the economy. This helped contribute about 2.5% to the inflation rate.
Then, there's the loan repayment pause we mentioned before. This is money that borrowers didn't receive as a check. Instead, they simply had one fewer bill to pay each month. Because these savings occurred over time, they had a minimal effect on inflation—only about 0.2% each year of the pause.
In 2020, the inflation rate was 1.2%. Today, it stands at 8.2%. The pause's effects on that rise are minimal. Considering loan forgiveness is spread out over a very long time and covers only a portion of a bill for most people (rather than removing an entire bill from their financial burden), it's likely to have an effect closer to the pause than the stimulus.
The bottom line
Student loan forgiveness is unlikely to have a large impact on the stock market. But it's also unlikely to have a large impact on the inflation rate, which is a positive in the long run. If inflation steadies or falls, interest rates could eventually come down and help stock prices.
But that seems so far in the future as to be unpredictable. Right now, all we can do is keep our eye on the Federal Reserve and the decisions they make.
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