When President-Elect Biden takes office in January 2021, there will certainly be a lot on his plate with COVID-19, the vaccine, the economy and foreign affairs. Needless to say, student loan reform for the Biden Administration might be a low priority for at least the first few months.
That might leave student loan borrowers in limbo with how they should attack their student loans.
Should you refinance your student loans during the Biden Administration, or stay in the federal loan program in case a better income-driven repayment plan or expand student loan forgiveness is offered?
The Biden student loan plan
Travis just wrote a great article on the Biden Student Loan Plan with all of the details.
Here are some of the plan highlights that could affect how you approach student loan repayment. Just keep in mind that some of this will rely on the composition of Congress and their support (or not) of the entire plan or pieces of it.
Expanded student loan forgiveness
Public Service Loan Forgiveness (PSLF) would be expanded to include previously ineligible loans (FFEL loans) and more jobs would be considered PSLF-qualifying employment.
It also proposes forgiving 50% of loans after five years of service, and possibly $10,000 per year rather than the current all-or-none tax-free loan forgiveness after 10 years of public service.
There’s also talk of forgiving $10,000 in federal student loans per person across the board.
Lower student loan payments on a new income-driven repayment plan
Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE) currently offer the payments based on the lowest percentage of discretionary income, 10%.
President-Elect Biden talked about cutting this payment in half. This could be an income-driven repayment plan based on 5% of discretionary income. This, alone, can make refinancing completely unattractive to many six-figure borrowers.
That said, we don’t think this will likely pass, but it shows a willingness to ease the payment burden for those with student debt.
Eliminate the tax bomb on student loan forgiveness
After making 20 to 25 years payments on an income-driven repayment plan like PAYE, REPAYE, or Income-Based Repayment (IBR), the remaining loan balance is forgiven.
Under the current rules, that student loan forgiveness would be considered taxable income resulting in a tax bomb due at the end. The Biden Plan proposes to make that forgiveness tax-free. Congressional Republicans had been entertaining this idea, too.
That would be a game-changer for those with six-figure student loan debt, and we think it’s likely to happen at some point either during or after a Biden presidency. It could reduce the cost of loan repayment by tens and even hundreds of thousands of dollars.
Biden student loan plan vs. Trump plan
The Biden Administration’s approach to student loans would be a shift compared to the last four years.
During the Trump Administration, borrowers with student loan debt feared that he (and Congress) would get rid of student loan forgiveness and create a more expensive income-driven repayment plan.
This would make the cost of paying back federal student loans more expensive for borrowers and push more people toward student loan refinancing.
But with the incoming Biden Administration, it seems more likely that student loan forgiveness programs will remain intact and maybe even be expanded to include more people. That would make student loan refinancing less appealing for six-figure borrowers.
Student loan forgiveness vs. refinancing in a Biden Administration
Let’s now see when student loan refinancing could make sense during a Biden Administration.
We’ll compare student loan refinancing vs. PAYE vs. a PAYE-like program where payments are 10% of discretionary income with no tax bomb (likely the most probable outcome).
We won’t compare the super aggressive plan where the income-driven payments could be 5% of discretionary income, because we think both are unlikely. I also won’t compare PSLF, because that will often beat all three of the proposed scenarios.
Emily is a veterinarian with $200,000 of vet school debt at 6.8% and is earning $100,000 (a 2x debt-to-income ratio) with income projecting to increasing 3% per year. She could refinance to a 10-year term at 4.5%.
How would her repayment compare under these options?
The Biden Plan would easily be the most affordable for her. It’s the least amount of money out of pocket and the payments are spread out over 20 years instead of having to make $2,000+ private student loan payments for 10 years.
PAYE with the tax bomb would actually also be better than refinancing in terms of maximizing her net worth and getting her to financial independence faster. It has a lower net present value than refinancing.
Let’s look at another scenario. Milan is a dentist earning $250,000 with $375,000 in student loans at 6.8% (1.5x debt-to-income).
On the surface, it looks like refinancing would save the most money since it’s the lowest cost out of pocket, but PAYE without a tax bomb has a lower cost in today’s dollars. Plus, the payments would be close to $2,000 less per month starting out on PAYE vs. student loan refinancing.
In this scenario, we’d lean toward PAYE with no tax bomb while committing to aggressive savings on the side to reach financial independence faster.
Final scenario. John is a lawyer earning $100,000 and has $100,000 in law school debt at 6.8% (a 1x debt-to-income ratio). His income is projected to grow at 3% per year.
This is a clear-cut refinancing scenario. Because of his “low” debt-to-income, his income-driven payments would be high enough that he’d end up paying off his loans in full with no loan forgiveness. In essence, he’d end up paying off a high-interest loan over a long period of time which is very expensive.
Refinancing student loans would save him nearly $60,000 and 10 years vs. PAYE and even a Biden version of PAYE.
Student loan refinancing rule-of-thumb might change
When Student Loan Planner first started five years ago, we used to say that refinancing should be considered for people with a debt-to-income of 2x or less given the student loan climate at that time.
Then REPAYE came on the scene and Congress started to show it being student loan borrower friendly so we lowered our threshold to a 1.5x debt-to-income.
But based on the Biden Administration student loan plan, and bipartisan Congressional action to suspend payments and interest with the CARES Act, we feel that student loan repayment could continue to get easier for federal student loan borrowers.
If the tax bomb ends up getting eliminated, then we would most likely lower the threshold of refinancing to a 1:1 debt-to-income or lower for those who aren’t eligible for PSLF or other federal loan forgiveness programs.
The bottom line is that if you’ve been working toward forgiveness (either tax-free with PSLF or taxable), it probably makes sense to stay on that path during a Biden Administration.
If you were thinking about refinancing, you might want to wait a little bit longer to get more clarity on what student loan reform could look like and how it takes shape.
How to refinance student loans
Consider student loan refinancing if you:
- Owe less than your income
- Don’t plan on going for loan forgiveness
- Have a solid emergency fund
- Have enough cash flow for the monthly payment
Remember that when you refinance with a private lender, you’re pulling your loans out of the federal program. You’ll lose all eligibility for loan forgiveness or other favorable terms for the life of the loan.
Interest rates are at, or near, historic lows so fixed interest rates are more appealing than a variable rate loan unless you plan to pay it off in three to five years or shorter.
Refinance student loans through Student Loan Planner to find the best rates and terms as well as some of the best cash back refinancing bonuses out there. Be sure to pick the repayment terms that fit in best with your overall financial situation.
If you’re not sure whether to do a student loan refinance or pick the optimal plan within the federal student loan program, we can help. Book a student loan consult to get a clear understanding of what plan will save you the most money and how to implement it.