May 17, 2020

Student Debt Forgiveness: Let's Do Some Math

What would it cost to wipe out everybody’s student loans? The answer may surprise you.
By Sparky Abraham /
Student Debt Forgiveness:  Let's Do Some Math

Today the Debt Collective launched a national student debt strike. This is a continuation of work that the Debt Collective has been doing for years, lifting up the voices of those in debt to demonstrate the cruelty and disastrousness of our student loan system. So far, their strategy has been quite successful. Large-scale student debt forgiveness is now a major policy issue among the Democratic presidential candidates, and the relevant questions have shifted from “should student debt be forgiven” to “how much debt do we need to wipe clean” and “how should we do it?” 

As politicians and presidential candidates spar over their student loan forgiveness plans, the question of “cost” crops up but, so far, has not been satisfactorily answered. Thinking through the problem, we find two interesting and apparently—though not actually—contradictory points. 1) The effects of the student debt crisis are more severe than many people assume; but 2) it would cost less to fix than most people expect.[1]

Right now, a little more than $1.5 trillion of student debt is owed to the federal government. (When media and politicians talk about student debt, they often use a slightly higher number—$1.6 or $1.7 trillion—because they are including the approximately $125 billion of private student loans owed.) How much would it cost the government to forgive all student debt? Most media outlets assume that the cost of cancelling debt is a number equivalent to the balance of the debt itself. NPR recently claimed that forgiving $1.6 trillion of student debt would cost $1.6 trillion. The New York Times also said that Sanders’ full student debt forgiveness policy is a “$1.6 trillion plan.” Seems simple enough.

It’s not simple. It’s not simple because the total amount owed on a loan and the “cost” of forgiving it are not, and have never been, the same thing. Lending money is a gamble on the future. Lenders have always known this. The real cost of forgiving a loan is what the lender can reasonably expect to collect on the loan. And that is almost always different from the current loan balance.

(Note: From here on I’m going to only talk about federal student debt, because that’s 93 percent of all student debt and it’s more interesting. The cost of forgiving private debt is probably the cost the federal government would have to pay to private lenders to buy the debt. It’s an interesting question, and ends up having similar features, but it’s a discussion for another day.)

In many situations, loan forgiveness costs more than the principal balance forgiven. For example, if I give you a 30 year mortgage for $400,000 at 4 percent interest, I expect to make money on that loan. If you pay your mortgage, after 30 years you will have paid me a grand total of $687,478! But forgiveness can also cost much less than a loan balance. If I give you the same mortgage, but then the value of your home drops to $100,000 and you lose your job, I am very unlikely to collect $687,478 from you. In fact, I am very unlikely to collect $400,000. It’s possible the best I can do is collect $100,000 through foreclosure. So forgiving your debt doesn’t really cost me $400,000. Forgiving your debt only costs me $100,000, because that’s the most I could hope to collect.

So what if I gave you a student loan for $50,000 at 6 percent interest for 10 years? If you made all your payments, you’d pay $555 per month for a total of $66,612, and I’d make $16,612 in interest. But what if, realizing that you’re struggling and that you’re unlikely to be able to pay $555 per month, I gave you some other options. Let’s say I allowed you to pay only a certain percentage of your income, and/or not pay at all if you fell below an income threshold. Now, in this scenario, how much would I expect to recover of my $50,000? It’s very hard to say. If you, the borrower, were to pay less than $3,000 a year, you wouldn’t even cover the interest on your loan, and your balance would actually grow. So if you spent 10 years paying nothing, and then, let’s say, got a good job and spent the next 10 years making normal payments, I would recover a lot more than $50,000 or even $66,612. (How much more would depend on whether the interest compounded and when, which is also a somewhat complicated question in the student loan context. But if the interest only compounded when you switched from no payments to normal payments, then you would end up paying me a total of around $56,000 in interest on top of the $50,000 original loan, for a total of $106,000.) 

Or maybe you would spend a full 50 years paying only what you can afford, which is $2,000 per year. In that case, you would never even begin to pay off the original $50,000 I loaned you. Every payment you made would fail to cover interest charges, and therefore the interest would keep growing. At $2,000 a year over 50 years, I would recover $100,000, and you would still owe me a very large balance. 

You and I might decide this is very unfair: No one with an ounce of compassion or decency would want to trap someone else in unaffordable debt peonage for 50 years with no conceivable escape. So you and I might agree that you will make payments for 25 years, and if you can’t pay off the debt then I will forgive whatever’s left. I will also agree to forgive whatever you owe if you die, so your children aren’t burdened with your student debt. Only some kind of shameless monster would want family members to pay off their dead relatives’ student loan debt.

Okay: So what would it cost me to simply forgive your $50,000 student loan? It depends entirely on what you might have done, the various futures you could have lived. You might have immediately gotten a job and paid it off as planned, so by forgiving your debt I would be giving up $66,612. Maybe you would never have been able to make a single payment for 25 years, or until you died, meaning I would have gotten nothing and will lose nothing[2] (but you will gain freedom from this unreasonable obligation). Maybe you would have spent 20 years paying nothing at all, your balance building and building as the interest compounded, until the day you suddenly won the lottery and paid back your full balance, in which case forgiving your $50,000 debt could cost me a $100,000 or more (again, this would vary greatly depending on how the interest compounds). It’s very hard to pin down how much forgiving your debt would cost me, because I don’t know what your future will be like. I could be giving up nothing, or I could be giving up a whole lot. 

Of course there are some methods I could use to try to predict what is likely to happen. If I give out a whole bunch of student loans, and the vast majority of people make their normal payments on the normal schedule, then I know that forgiving any one of them is likely to cost me something closer to the loan balance plus interest over a 10 year period. If I give out a whole bunch of student loans and a large chunk of the borrowers can’t afford their payments, and spend years or decades paying less than interest, then forgiving any one of the loans is unlikely to cost me a whole lot. I’ll probably end up having to forgive many of them anyway after 25 years or when the borrowers die. Most people don’t win the lottery.

This may have been obvious to you already, but the circumstances laid out in the previous examples represent our current federal student loan system. Yes, student borrowers collectively owe around $1.5 trillion in federal loans. But the way repayment works is that people only have to pay a percentage of their income—so-called Income-Based Repayment. So, while some people pay off their loans through normal 10 year plans, many other people only write checks for amounts that will never pay off their balances, and in fact their balances get larger every month. And federal student loan rules say that if a borrower is on Income-Based Repayment for 25 years (or 20 years or 30 years depending on the type of loans), their balance should be forgiven. Not only that, federal student loan rules also provide for a “death discharge,” a.k.a. student loan forgiveness for borrowers who die in debt. Debt forgiveness is already baked into the system in certain circumstances.

So, again, if everyone who owed a student loan was able to pay back their debt, the federal government would lose more than $1.5 trillion in future revenue by forgiving it all. But if a substantial number of people are likely to struggle for 25 years or die in debt, never paying off more than a fraction of the loan, then forgiving all debt will cost much less than $1.5 trillion.[3] So which is it? How much does it actually cost to forgive student debt?

No one knows. As Jordan Weissmann noted last year in Slate, even the wonkiest wonks don’t have a way to figure this out. The Department of Education doesn’t publish the data you’d need to get a reasonably accurate picture of student loan repayment and estimate the cost of forgiveness. What we’d need to know is how many people are likely to get forgiveness already. That means we need to know how many people are stuck in income-based repayment and likely to remain there, and how many people are likely to die before they pay their full balance (or, often, any of their balance). The Department of Education doesn’t publish any of this information.

But we do have some relevant data. For one thing, only 56 percent of the total federal student loan balance was in repayment last year, meaning that the other 44 percent—more than $500 billion—is not in any kind of repayment at all. That could mean it’s in default, or that the borrowers are in school, or that they have temporary forebearance (meaning they’re not making payments but are also not in income-based repayment; the CFPB is currently suing Navient for pushing students into forebearance, where they accrue interest but make no progress toward forgiveness, instead of income-based repayment). So of that whole $1.5 trillion, only 56 percent is in any kind of repayment at all. This doesn’t mean that the 44 percent not currently paying their loans will never pay their loans, but it does mean that the federal government is currently collecting payments on a much smaller portion of the whole student debt pie than many people assume.

What of the 56 percent of outstanding loans in repayment? How are the borrowers doing? Well, as of the fourth quarter of 2019, the Department of Education reports that only 45 percent of the loans in repayment were in standard (i.e., full) repayment plans.[4] A full 55 percent of outstanding federal student loan dollars are enrolled in some form of income-based repayment. Does this mean that all of these people will never pay back their loans and will definitely get forgiveness, either after decades of struggling or when they die? No, of course not. But it does mean that far, far more of our outstanding student loan dollars are on a likely path to forgiveness already. 

How many people take out student loan debt, get a high-paying job, and then spend a mere 10  years making interest and principal payments on their loans? Not that many. That kind of debt only accounts for about 19 percent[5] of the current outstanding student loan balance. A little less than 6 percent[6] of the debt is being repaid over a longer but still steady period of time. And around 75 percent[7] of student loan dollars right now are either not being paid back at all, or are being paid back in a program indicating that the borrowers are struggling, such as income-based repayment plans, which may eventually result in forgiveness.

Interestingly, one place you will find people who understand this issue—who are fully aware that a substantial portion of outstanding student debt is likely to be forgiven no matter what happens—is on Wall Street. As the Wall Street Journal recently reported, investors in FFEL loans[8] are extending the maturity date on student loan-backed securities, i.e., formally accounting for the fact that the student loans will not be paid back on their normal expected schedule. The investors aren’t making this move because they expect that, given more time, students will be able to pay back the loans. They’re doing this because they recognize that the students won’t be able to make the payments, and the government will eventually have to forgive the loans, at which point the government will pay out its guarantees. So the investors will get paid either way, and their extension of the bond maturity is in recognition that they are unlikely to get paid by students and more likely to get paid by the government.

What does this all mean? First of all, it means that our student loan system is a lot harder on people than it is often portrayed to be. The normal system—get the loan, pay it back in set payments over time—is only working for about a quarter of loans. A full 75 percent of student debt is held by people who are either not paying at all, or who are paying some amount that is calculated depending on their income. And since the income-based plans are only helpful for, and often only available for people who can’t afford their normal payments, this means that a lot of people are in trouble with their loans, and may be eligible for forgiveness in the future under the system as it already exists. If this is true—if the future of student debt right now is that a large portion of it will be forgiven—then immediate forgiveness costs far less than $1.5 trillion. How much less is impossible to say, but the existence of 75 percent not in normal repayment should give us a clue.

Here’s what this doesn’t mean: that people struggling with student debt will just get it forgiven eventually so we don’t need to do forgiveness now. In fact, these numbers should make it clear how desperate the situation is, and how urgently necessary it is to have student debt forgiveness. We’ve discovered that forgiving student loans might be cheaper than people think, because so many people are on track to be in debt for decades or until they die with no escape

Debt makes it harder to find housing, harder to get a job, harder to get insurance, harder to stay married, harder to stay healthy, harder to have any kind of stability in your life. If many student borrowers will get loan forgiveness when they die, that means by not forgiving their debt now, we are condemning people to lives in miserable debt for little or nothing. We will extract very little from them, and they will suffer immensely. Debt forgiveness in many cases means that the federal government gives up nothing while many people enjoy a much better life. 

Of course, in the aggregate, the government will give up something. Some people do pay back their student loans, so forgiveness will lose the government some money in that sense. But we can see that the loss may end up being very little. And we have good reason to think that forgiveness will have massive economic benefits that will likely more than compensate for any loss.

Personally I believe the “cost” (such as it is) of forgiving student loan debt is ultimately not the deciding factor here. Our higher education financing system has, since its inception, operated as a tool of segregation, enriching schools, employers, and financiers at the expense of poor students, especially women and people of color. Student debt is a regressive tax. Many colleges used to be free and they ought to be free again. Once you recognize that student debt is an unjust imposition in the first place, and once you see the level of suffering it has caused and is still causing, forgiveness is a moral imperative irrespective of “cost.” It just so happens that the “cost” of forgiveness is likely much lower than people think. 

  1. Disclaimer: It’s a bit misleading to talk about “cost” in this context for a couple of reasons. First, we’re talking about a lender—the federal government—potentially forgiving a debt owed. At least for federal student debt, the government doesn’t have to send out any checks to wipe that debt clean. They don’t owe any money to anyone; the debt is just a number in their books. So this isn’t a question of government payment. Rather, it’s a question of how much future revenue in the form of loan payments the government is giving up. But, even then, we should be careful about how we think about government revenue, especially future government revenue. Modern Monetary theorists have explained at length that government revenues don’t need to match government expenditures. So we should take care not to fall into the trap of thinking that if the government gives up revenue by forgiving student loans, it must therefore recoup it elsewhere in the budget. I’m still using the word “cost” here because there isn’t a good alternative word for the money the government would forego collecting on student loans, but keep in mind that it’s a very different kind of “cost” from the cost of a loaf of bread, or the money you personally spend repaying your student loans.
  2. Obviously I have lost something. I lost the $50,000 I loaned you. But I lost that the moment I loaned it to you. At the point when I forgive your debt, my options are to forgive your debt and collect nothing, or to refuse to forgive your debt and collect nothing. Either way I am getting $0 from you. So though I have lost $50,000 overall, I am not losing anything by forgiving the debt.
  3.  Note that in our example, if you were only able to pay me $3,000 per year you would cover the interest charges and nothing more. After 25 years you will have paid me $75,000—more than I would have made if you could afford your normal payments, just over a longer time period—while you would still owe me $50,000. So it’s not always true that income-based repayment is a good deal for students and a bad deal for the government.
  4. This analysis excludes so-called “alternative” payment plans, which are something of a hybrid—negotiated payment plans based on what borrowers can afford when they have loans that are not eligible for the normal income-based plans.
  5.  Around 34 percent of the 56 percent in repayment.
  6. Around 11 percent of the 56 percent in repayment.
  7. 44 percent not in repayment plus 55 percent of those in repayment.
  8. A now-defunct program where the federal government guaranteed loans issued by private-ish entities.
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