Student debt relief lets clients use their money more productively

President Biden’s plan to provide debt relief for many people who borrowed to go to college would liberate money for more productive uses by borrowers, financial advisers said. But they didn't fully embrace the proposal as good policy.

Biden announced Wednesday that the government would forgive up to $10,000 in federal student loans for people who earn less than $125,000 annually and up to $20,000 for those who took out Pell Grants, according to a White House fact sheet.

The package includes an extension of the loan repayment moratorium, which began at the start of the coronavirus pandemic in 2020, to the end of the year. It also would cap repayments for undergraduate loans at 5% of a borrower’s monthly income, among other changes in the loan system.

“This is finally going to conclude the wait-and-see pattern I’ve seen with clients in this income range,” Jeffrey Edwards, president of Atlas Financial Planning, said of people who have student loans and make less than $125,000. “Now is their chance to ramp up their savings [with] this free cash flow.”

The money that had been devoted to paying off college loans could now be put toward retirement savings and other efforts to build a solid financial foundation.

“Theoretically, they could get themselves on better financial footing by investing that [loan repayment] money,” said D.J. Hunt, a senior financial adviser at Moisand Fitzgerald Tamayo.

Crystal Cox, senior vice president at Wealthspire Advisors, had been counseling clients to make minimum payments on any kind of debt given the low-interest-rate environment.

“That strategy has worked out even more in our clients’ favor” with the federal student loan forgiveness," Cox said. “This is a great opportunity to free up cash flow on a monthly basis” and put it toward “short-term and long-term goals.’

But there also will be a price to be paid for the debt relief, warns Luke Neumann, an adviser at Crestwood Advisors.

“Plan for tax incidents related to the loan forgiveness,” Neumann said. He suggests setting aside $100 or $200 a month in a high-yield savings account to finance the tax payments.

The student debt cancellation would ease financial pressure on low- and middle-income Americans as higher education costs soar, the Biden administration said. It said 43 million people could qualify for the relief, and 90% of them would make less than $75,000 annually.

“The skyrocketing cumulative federal student loan debt -- $1.6 trillion and rising for more than 45 million borrowers – is a significant burden on America’s middle class,” the White House fact sheet states. “Middle-class borrowers struggle with high monthly payments and ballooning balances that make it harder for them to build wealth, like buying homes, putting away money for retirement and starting small businesses.”

Senate Minority Leader Mitch McConnell, R-Ky., said the plan would stoke inflation and called it “unfair.”

“President Biden’s student loan socialism is a slap in the face to every family who sacrificed to save for college, every graduate who paid their debt, and every American who chose a certain career path or volunteered to serve in our Armed Forces in order to avoid taking on debt,” McConnell said in a statement. “This policy is astonishingly unfair.”

That’s also a criticism that Hunt leveled.

“Generally speaking, I think it’s a bad idea because it transfers the [loan] liability from the person who has the [college] degree to the taxpayer,” Hunt said. “People who don’t have degrees are going to be paying for the degrees of people who do have them.”

Cox has mixed feelings about the debt cancellation. Like many who will receive loan relief, she’s looking forward to putting her monthly payment to other uses, a trend that will boost consumer spending. But that also could increase inflation as the Federal Reserve is trying to crimp it.

“I don’t know that the timing is good,” she said. “But in the longer term, people will feel more confident in their financial situation, and that will lead them to a healthier mental state.”

Capping debt forgiveness at a certain income level makes it less expansive than some progressive Democrats demanded while providing the relief many in the party sought.

“Biden has done a good job of walking a fine line here,” Neumann said.

Plenty of people paying student loans won’t benefit from the cancellation once the moratorium ends next year because their incomes are too high.

“We’ll have to build their financial plan around the repayment schedule,” Edwards said.