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You Are Here: Home » College » What is the Student Loan Forgiveness Act and Is It a Good Idea?

What is the Student Loan Forgiveness Act and Is It a Good Idea?

Published or updated September 21, 2013 by Kevin Mulligan

Earlier this year a new bill was introduced to Congress called the Student Loan Forgiveness Act of 2012.

The potential legislation has some massive changes for the student loan industry.  Is this new student debt legislation a good idea or something that should be shelved by Congress?

What is the Student Loan Forgiveness Act?

The Act would make wide changes to the massive student debt load in the country.

In 2010 total student loan debt exceeded total credit card debt for the first time.  The Act is also in response to a poor economy: the idea is that former students are too cash strapped from paying their loans to spend any money in the economy and relieving them of this debt would greatly improve the consumer economy.

10/10 Payment and Forgiveness


The first major part of the law is what is being called “10/10” where the student loan payments would be kept at 10% of a borrower’s discretionary income.

After 10 years of consistent payments, under certain rules, they could qualify for forgiveness of the remaining amount of the loan.  For borrower’s that fall after the Act becomes a law, their forgiveness would be limited to $45,520 in principal, fees, and interest.  For borrower’s that had loans before the Act becomes law, there is no cap.  That means someone who has been paying their loans for 120 months could, in theory, wipe away the remaining debt immediately if the legislation is passed into law.

Capped Interest Rates

The interest rates on student loans has also been in the news recently.

With this legislation all federal student loans would be capped at 3.4%.  Currently undergraduate loans that are subsidized by the government are at 3.4%.  However, undergraduate unsubsidized and graduate unsubsidized loans are currently at 6.8%.

Better Public Service Loan Forgiveness

The legislation would also drop the number of months you would need to have in public service for loan forgiveness.

Currently you must be employed for 10 years (120 payments) before loan forgiveness kicks in.  Under the new legislation that would be cut in half to 5 years (60 payments).

Should the Student Loan Forgiveness Act Be Voted Into Law?

student loan forgiveness
Is the Student Loan Forgiveness Act a good idea for students and the economy?

Forgiving massive amounts of debt across the country (now estimated to be more than $1 trillion) is bound to free up some extra dollars to be spent within the economy, right?  That spending would result in job growth, tax revenue growth, and so forth.

Even if that were all true there is a serious flaw to this and other loan forgiveness ideas.

How Credit and Lending Works

It all revolves around how credit works.

When I let you borrow money from me, that loan is based on trust and qualifications.  I believe that you will do everything you can to pay me back.  I’ll charge a fair interest rate for the risk I am accepting which is normally set by market conditions.  If I wanted to charge you more than the market did, you could go elsewhere, so I play along.

You get your loan (and education) and I get to earn some investment income.  We both win because I had trust that you would pay the loan back.

Now change the rules to where loans can be “forgiven”.

From a lender perspective that sound an awful lot like “written off” which means “I lent money and never got paid back”.  You’re telling me I should want to continue to loan money to someone that, in a few years, would have the option of not paying the balance back to me?  No right minded lender would accept this situation and simply stop lending.  To do otherwise would be insane.  You don’t lend money to people who can walk away whenever they feel like it — at least not without being able to charge an adequate interest rate.

Those interest rates is the second problem.

Let’s say I’m willing to take the risk that you will walk away from the loan at some point in the future like you would with a credit card.  As a reaction to this increased risk, I would then charge an increased rate so that my investment return comes out about the same.  While the government controls the Federal loan interest rates, they cannot control the private market.  And private student loan rates would skyrocket to compensate for the increased risk.

The third problem is financing the loan forgiveness.

Let’s say all $1 trillion of the estimated student loan debt out there is Federal loans.  If Congress passes the law that wipes out that debt, that’s $1 trillion the United States won’t be paid back.  (Plus any interest that would have been earned. At just 3.4% and $1 trillion, that would be $34 billion per year.)  Our current national debt is about $16 trillion.  You would then immediately bump up that amount to $17 trillion. (Not to mention trying to explain to your fellow taxpayer that the increased taxes he pays in the future are to pay for your free student loans while he paid for college by working his way through or saving up like a financially wise person.)

Final Thoughts

What do you think?

Should we as a country allow widespread loan “forgiveness”?  There are tempting numbers — $1 trillion in debt that could be used in the consumer economy — to consider.  But are the risks too great?

Let us know your thoughts in the comments!

Filed Under: College, Debt Tagged With: student loan debt

About Kevin Mulligan

Kevin Mulligan is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. He's building a personal finance freelance writing career and has written for RothIRA.com, Discover Bank, ING Direct, and many others.

Reader Interactions

Comments

  1. Aaron M says

    August 28, 2012 at 8:54 am

    I agree that it isn’t good for the economy, but the thing that isn’t being talked about in your article is the cost of college and how completely ridiculous it is. When you come out of a 4 year college and start working a $25,000 a year job, but owe $35,000 in student loans, it is completely ludicrous to assume that that will be able to happen at any reasonable rate.
    The cost of college tuition needs to come down to give people the opportunity to actually be able to pay for their education without taking out an amazing amount of student loans that haunt them the rest of their lives.
    The collegiate system needs to be overhauled, whether that means the method, or the cost, something needs to change.

    • Joe Morgan says

      September 14, 2012 at 2:54 pm

      You’ve hit upon the real problem here, and unfortunately low interest government loans are a big part of the problem, and not the solution as advertised.

  2. Andy Hough says

    August 28, 2012 at 11:38 am

    The current forgiveness rules are already pretty good. You need 10 years of public service. Or you can pay no more than 15% of your disposable income and have the loan forgiven after 25 years. The new rules probably aren’t a good idea, but if they were enacted I would have no qualms using them to have my loan forgiven.

    • Christine says

      August 28, 2012 at 12:09 pm

      I second Andy’s thoughts on this. especially the last. my SLs are serious baggage.

  3. Shaun Connell says

    August 28, 2012 at 2:49 pm

    Forcing me to pay someone else’s loans is just pure evil. I dropped out of college because of the cost. I could have gone into debt. I responded to what made sense. I was mocked by people now calling for me to pay their loans.

    Heck no. It is immoral. If you made a choice, you should live with it. And anyone who thinks they -deserve- me to pay their loans has a very broken philosophy.

    We need personal responsibility in America, not less of it. And yes, that means making bad choices can keep you from doing well financially. That is the -whole- point.

    • Yoshi Inoue says

      August 29, 2012 at 2:46 am

      Why is helping educate people pure evil? I don’t understand…
      It’s not the matter of self-worthiness, it’s about helping the community.

      I didn’t want to pay to bailout Wall Street, rather see them in jail, but I had no choice. That is immoral to cover/protect criminals like those. They don’t deserve my hard earned money.
      I believe that you agree with me on this correct? Based off of your argument.

      Also making those choices maybe the only choice they have to get them the dream job.

    • Joe Morgan says

      September 14, 2012 at 3:05 pm

      You make a great point Shaun and it’s one that many sadly do not understand. There is no free lunch, and even those who have their loans ‘forgiven” will end up paying for their loans and everyone else’s loans through higher taxes, or a reduced standard of living as the government inflates away its debt obligation.

      In the end, socializing (or communalizing) the debt obligation is not compassionate and does more harm than good.

  4. Yomar says

    August 28, 2012 at 3:39 pm

    It’s an excellent legislation, it should be approve immediately! Student debt, is drowning the economy and the middle class. This legislation will help boost the economy, by leaving more money in peoples hands.

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