September 01, 2022
Last week, President Biden announced a plan to cancel up to $10,000 in federal student loans per borrower. Recipients of Pell grants will be eligible for up to $20,000 in canceled debt.
The details are still being worked out, and I would not be surprised if the proposed student debt relief faces a legal challenge. But I know so many of you are eager to understand if you will qualify for any debt relief.
The first thing to know is that the current “pause” on federal student loan payments is extended through December 31. The Biden administration says this is the final extension of the freeze in payments due (without interest accruing) that began at the start of the pandemic. If you expect you will still have an unpaid loan balance in 2023, now is the time to make sure you have a plan for making those payments on time.
Okay, now let’s dive into the debt relief program.
Who is Eligible
1. Individuals with income below $125,000 and married couples that file a joint tax return with income below $250,000 will be eligible for debt relief.
2. All borrowers with federal loans are eligible: undergrads, grads and parents with PLUS loans. Private loans are not covered by this proposed program.
3. Current students are eligible for loans taken out before July 2022. But if you are still claimed as a dependent on a parent’s tax return your eligibility is based on their income, not yours.
Debt Cancellation Maximums
Up to $10,000 in federal student loans per qualified borrower will be canceled.
Up to $20,000 in debt will be canceled if the borrower also received any Pell grants.
Applying for Debt Relief
Most borrowers will need to apply for debt relief. The Department of Education is still in the process of figuring out the application process. They expect to announce the plan in October. No need to stress though, the Dept. of Education says the application will be simple.
I will keep you updated on things, but I also highly recommend you subscribe to a free email notification from the Dept. of Education. Click the first box on the page: “Federal Student Loan Borrower Updates” to stay up to date on when the application process will launch.
How Soon Debt Will be Cancelled
The Dept. of Education is aiming to cancel eligible debt within 4 to 6 weeks after receiving an application. The goal is to process all applications received by mid-November before the “pause” expires on Jan 1, 2023.
Taxation of Forgiven Student Loan Debt
There will not be any federal income tax due on canceled debt. If you live in a state that levies its own income tax, you will need to stay alert to how your state chooses to treat any canceled federal student loans.
Making Remaining Debt More Manageable
The plan includes other provisions that are aimed at making repayment of loans that exceed the $10,000/$20,000 limit less of a burden for many borrowers:
More income will be shielded from the repayment formula. New rules will shift more of the borrower’s income to “non-discretionary”, and that money is not considered when calculating the monthly payment due. If this proposal is enacted it could dramatically reduce many borrowers’ monthly payments.
Borrowers enrolled in an income-driven repayment plan for undergrad loans will have their monthly payments capped at no more than 5% of discretionary income. The current program sets payment at 10%.
No more growing balances. Even if your monthly payment does not fully cover the interest due, that interest payment will no longer be added to your balance.
If your original loan balance was less than $12,000, any remaining balance after 10 years of on-time payments will be canceled. The current rule requires 20 years of on-time payments. This change is expected to ensure that community college borrowers will be out of debt within 10 years.
Refund Option if You Made Payments During the “Pause”
For those of you who continued to make loan payments between March 13, 2020 (the official start of the pandemic student loan payment pause) and August 31, 2022, you can apply for a refund of those payments. That may make sense if you are eligible for the loan forgiveness program; once the money is refunded you can then apply for cancellation. But that only makes sense if your remaining balance is currently below $10,000 ($20,000 if you received a Pell grant) and you want to be eligible to claim the full cancellation amount.
As we learn more in the coming weeks, I will update you on what you need to know. In the meantime, if you will benefit from this student loan cancellation, I hope you are already plotting how to make the most of it. If your payment is reduced or wiped out completely, what will you do with those dollars? My two top suggestions: building up your emergency savings fund and paying down any high-rate credit card debt.
Listen to my recent podcast episode “What You Need To Know About The Federal Student Debt Relief Program” to learn more.
Answer Yes or No to the follow statements.
I pay all my credit card bills in full each month.
I have an eight-month emergency savings fund separate from my checking or other bank accounts.
The car I am driving was paid for with cash, or a loan that was no more than three years, and I sure didn’t lease!
I am contributing at least 10% of my gross salary to a retirement plan at work, or I am saving at least that much in an IRA and/or regular taxable account.
I have a long-term asset allocation plan for my retirement investments, and once a year I check to see if I need to do any rebalancing to stay on target with my allocation goals.
I have term life insurance to provide protection to those who are dependent on my income.
I have a will, a trust, an advance directive (living will), and have appointed someone to be my health care proxy.
So how did you do?
If you answered yes to every item, congratulations. If you are working on improving on a few items, I say congratulations as well.
As long as you are comitted to truly creating financial security, I applaud you. If that means you are paying down your credit card balances, or are building up your emergency fun with automated payments, that’s more than fine. You are on your way!
But if you found yourself saying No to any of those questions, and you’re not working on moving to Yes, then I want you to stand in your truth. No matter how good you feel, you have some work to do before you can honestly know what you are on solid financial ground.