Student loan debt is a clear problem in the U.S. Whichever side of the political spectrum you're on, and whether or not you agree with President Biden's loan forgiveness plan, student debt that is spiraling out of control is a major problem for our nation.
It's also important to realize that the student loan plan released by the White House does a lot more than simply forgiving $10,000 or $20,000 per eligible borrower. There are several other provisions that are designed to fix the problem from a long-term perspective.
One of the biggest contributors to the student loan debt crisis
You may have heard student loan horror stories that go something like this. Someone borrows $70,000 to fund their education, enrolls in an income-based repayment plan, makes on-time student loan payments every month for five years, and then checks their balance. Now they owe $90,000.
The reason for this is that while monthly payments are limited to 10% of the borrower's discretionary income under most income-based repayment plans, the interest that accumulates on the loan is often more than the required payments. And under current law, any unpaid interest gets added to the loan balance.
Here's an example. Let's say that you graduate with $50,000 in student loan debt at an average interest rate of 6%. Your first job isn't a high-paying one, so you are only required to pay $150 per month under an income-based repayment plan. However, based on a 6% interest rate, the interest on your loans is $250 per month. Since your required monthly payment doesn't cover this, you have $100 in unpaid interest each month that is added to your principal balance. You can probably see how over time, this can start to add a significant amount to your debt. The mathematics of compound interest can be an investor's best friend but can create a nightmare scenario when borrowing money.
The most important part of the student loan relief plan
President Biden's student loan relief plan aims to modify income-based repayment plans in several ways, such as limiting the monthly payment to just 5% of discretionary income on undergraduate loans and decreasing the amount of income that is considered "discretionary."
However, there's also a provision that says income-based repayment plans will:
"Cover the borrower's unpaid monthly interest, so that unlike other existing income-driven repayment plans, no borrower's loan balance will grow as long as they make their monthly payments -- even when that monthly payment is $0 because their income is low."
This effectively eliminates the possibility of any student loan borrower's debt growing over time while they're making payments, which is one of the biggest aspects of the federal student loan program that can trap borrowers in an endless cycle of ever-increasing debt.
Will the president's student loan plan fix the problem?
To be perfectly clear, student loan balances growing due to unpaid interest is only one part of the problem.
There's also the issue of rising college costs. Over the past few decades, tuition and other college-related expenses have grown much faster than overall inflation, which has resulted in the need for students to borrow more money over time. While the plan aims to address this, it doesn't have many concrete details, other than creating a list of schools whose students are graduating with the highest debt loads.
Furthermore, student loan debt is the only major type of personal debt that isn't able to be discharged in bankruptcy, and the new plan does nothing to change that fact.
In a nutshell, the president's student loan plan isn't likely to solve the student debt crisis entirely, but it's important to realize that there's a lot more to the plan than the headline news of debt forgiveness.