The question of how student loan forgiveness would be funded doesn’t have a clear-cut answer, and ideas about how it would be paid for can be heavily influenced by a person’s political leanings. One recent survey found that the majority of Democrats support canceling some or all student debt, while most Republicans oppose any cancelation. Read on to learn more about this important issue.
Who Pays for Student Loan Forgiveness?
There’s no easy answer in terms of how plans to cut student debt would be funded. Government finance is complex. Typically, the federal government would need to foot the bill for student loan forgiveness, and the government would have two options to pay for it: cut spending or raise taxes. Making the situation more complicated is the fact that forgiven loans may have already earned a profit, which could make reconciling the impact of writing off this debt even harder.
In addition, viewpoints on student loan debt are often divided by political affiliation. Democrats are more likely to support debt cancellation and hold the government and lenders responsible for the high levels of student debt. Republicans, on the other hand, usually are against the idea of student loan forgiveness and often feel the borrowers themselves should shoulder some of the blame for the situation.
Spending Cuts and/or Higher Taxes
If some or all student loans were to be forgiven, here’s a closer look at some potential paths:
• Cutting spending, which can be challenging. Some financial and legal experts worry that cuts would wind up hurting education resources, such as universal pre-K and higher education initiatives. These could be trimmed to save money.
• Raising taxes, which could involve increasing individual income tax rates or reducing tax deductions, such as mortgage interest, charitable contributions, medical expenses, IRA contributions, and more. The government could also opt to raise taxes on corporations and the wealthy.
• A combination plan of the two methods: some tax cuts along with some tax hikes.
Neither Is Necessary
Another point of view to consider: Some pundits say that the cancellation of federal student loan debt won’t cost the government anything. They point to the fact that student loans were paid for by taxpayers when the funds were first disbursed.
They also hold that, over time, payments by borrowers of student loans to the Department of Education have almost been equal to the amount of money loaned out. In that way, they see the situation of forgiving loans as being close to break-even. One review found that the government collected about $85 billion a year in payments on about $95 billion a year in loans paid out. In terms of government spending, they believe forgiveness would not result in a major shortfall.
Proponents of this theory also say that records reveal that the Department of Education has been profiting on student loans over the years, and that gain can also be seen as an asset against which canceled federal loans can be compared.
Obviously, this is a complex issue with many different viewpoints regarding the best path forward.
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The Current State of Student Loan Forgiveness
It can be helpful to keep in mind the recent events surrounding student loan forgiveness.
• The Biden administration announced a $441 billion federal student loan debt relief program for borrowers who earned less than $125,000 ($250,000 for married couples) in 2022. This was blocked by the Supreme Court in 2023.
In the wake of this decision, the Biden administration proposed new initiatives in April 2024 to forgive $7.4 billion in student debt, including waiving:
• Accrued and capitalized interest for certain borrowers
• Debt for those eligible for the Saving on a Valuable Education (SAVE) Plan, in the event of a closed school discharge, and other forgiveness programs
• Student loan debt for those who entered loan repayment 20 years ago
• Debt for those who enrolled in programs or institutions that provided low financial value
• Debt for those who experience repayment hardship
In May, the U.S. Department of Education announced cancellation of $7.7 billion for certain borrowers under Public Service Loan Forgiveness Program (PSLF) and through the SAVE Plan, which offers borrowers a shortened forgiveness period. However, court orders recently halted the SAVE program after several states sued.
Where Does All the Canceled Debt Go?
It’s hard to say where all the canceled student debt would go, and it’s also difficult to forecast how much forgiving debt would cost the government, if anything. The government would at least have to adjust its revenue projections, even when the original principal has been paid off with interest.
One important note: Canceled student debt can have a positive impact on borrowers. It gives them more disposable income, which they can use in ways that stimulate the economy, from buying more consumer goods to taking out more mortgages.
Will My Taxes Increase if Student Loans Are Forgiven?
Many believe that federal student loan forgiveness, as planned, could transfer debt from borrowers who took out student loans to taxpayers, according to the U.S. House Budget Committee. This is a viewpoint that tends to be held by Republicans who are opposed to forgiveness for various reasons.
The Budget Committee has stated that approximately 87% of adults without student loans will wind up paying for the 13% of borrowers who borrowed for college and 56% of the student loan debt for graduate degree borrowers.
Currently, some estimates say that $1 trillion in federal student loan cancellation would mean an additional $2,500 tax bill for most Americans.
Another angle to consider: If borrowers’ debt is forgiven, it could be taxable. Borrowers would receive IRS Form 1099-C in this instance, and might need advice from a professional tax preparer.
Recommended: Guide to Student Loan Forgiveness
Will Private Student Loans Be Forgiven?
The Biden administration’s student loan forgiveness plans would not cancel private student loans, which come from private companies, including online banks. The forgiveness plans only apply to those with federal student loans, or loans that come from the U.S. Department of Education.
Unlike federal student loans, which borrowers apply for using the Free Application for Federal Student Aid (FAFSA), you can apply directly to the lender for a private loan. Unlike in the case of federal loans, you may need to undergo a credit check and may encounter less flexible repayment plans with private student loans.
However, private loan lenders may offer some benefits that are similar to those of federal student loans, including deferment (when borrowers can temporarily stop making payments and interest may not accrue), forbearance (when borrowers can temporarily stop making payments or make smaller payments and where interest does accrue), or unemployment protection.
It’s wise to check carefully with your lender to find out their exact policies.
Alternative Options for Paying Off Student Loans
Since the future of forgiveness is largely uncertain, borrowers can consider other ways to pay off student loan debt. They can take advantage of several alternative options, including putting extra toward principal, considering other repayment plans, making lump sum payments, and additional methods.
Here are several possible options:
• Put extra toward the principal: Putting extra cash toward your principal student loan can result in a faster payoff than by simply making your usual monthly payment. Putting an extra $100 toward your principal every month, for example, can make a difference. You will typically not pay prepayment penalties on private or federal loans, which is a charge that penalizes you from paying off your student loans early.
• Make lump-sum payments: If you have a lump sum, like a tax refund, a bonus, or other windfall money, you can put that toward your debt instead of spending it. If you can find extra money regularly (such as a couple of times a year), that could help you pay off your student loans. A side hustle can also help you make lump-sum payments as well.
You might also consider using the debt snowball method of taking care of your loans, which means you put money toward your smallest loan balance, then progress to larger loan balances after that.
• Check with your employer: Your employer may offer a student loan repayment benefit. Learn whether your employer will help pay for qualified educational expenses, including your student loan balance.
• Budget your money: Living on a budget is a great way to ensure you make on-time student loan payments. Though you’re shielded from penalties on late payments through September 2024 through an on-ramp period, it’s still good practice to avoid late payments so you don’t risk default later.
• Refinance or consolidate student loans: Refinancing means changing one or more loans to private student loans with a new interest rate, term, and monthly payment. Securing a lower interest rate means you’ll pay less interest over time. However, it’s important to be aware that refinancing federal student loans in this way means you will forfeit the right to certain benefits and protections, such as deferment. Also, if you refinance for a longer term, you may well pay more interest over the life of the loan.
• Consolidating federal student loans: This means pooling one or more federal student loans into a Direct Consolidation Loan with one monthly payment with one interest rate. You may save money over time when you consolidate, but check to be sure.
• Repayment plans: Several repayment plan options exist for both federal and private student loans. For example, with federal loans, you may look into several income-driven repayment plans, such as the SAVE, Pay As You Earn (PAYE), income-based repayment (IBR), and Income-Contingent Repayment (ICR) plans as repayment options. Check with your loan servicer to determine which makes sense for you, whether you have a mix of federal and private loans or just federal loans.
Recommended: Are Student Loans Forgiven After 20 Years?
The Takeaway
There are different opinions about how federal student loan forgiveness will be paid for, if and when it’s enacted. Viewpoints often align with a person’s political beliefs, with Democrats tending to favor loan cancelation and Republicans being against it.
Regardless of the future of student loan forgiveness, there may still be options to help you manage your student debt, such as budgeting, considering alternate repayment plans, or refinancing.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
FAQ
How will student loan forgiveness be funded?
Some experts claim that the government would need to cut spending or raise taxes to fund student loan forgiveness.
What impact will student loan forgiveness have on borrowers?
Pending legal blocks, borrowers could see some of their student loans disappear, providing relief for millions of borrowers. It’s also important to understand that student loan forgiveness may be subject to tax. You’d receive Form 1099-C to document it; consider checking with a tax professional to learn more about how tax applies in your situation.
What are the potential drawbacks of student loan forgiveness?
In addition to the potential for taxpayers to shoulder the debt, other downsides of debt forgiveness might include the forgiven amount being taxed, cuts to government educational spending, and overspending and increased debt for students who find themselves with more disposable income.
Photo credit: iStock/Drazen Zigic
SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.
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