Photo by Alp Ancel on Unsplash

This July, the US Department of Education announced the release of proposed new federal student loan regulations, using language that only a bureaucrat could love, but which nonetheless affect millions of federal student loan borrowers nationwide. (A four-page summary of the proposal is available here.)

According to the press release, the proposed regulatory changes seek to alleviate “student loan debt burdens for borrowers whose schools closed or lied to them, who are totally and permanently disabled, and for nonprofit and public sector workers who have met their commitments under the Public Service Loan Forgiveness (PSLF) program. The regulations also propose stopping many instances of interest capitalization, which occur when unpaid interest is added to a borrower’s principal balance, increasing the total amount they owe.”

What does this all mean? As should be obvious to all, the world of the $1.73 trillion federal student loan market is nothing if not opaque.


An Uncertain Environment

As many NPQ readers know, accumulation of interest on student loans has been frozen since March 13, 2020. The freeze originally was slated to expire in September 2020 but has been extended six times, most recently this past April, when the date to end the freeze was extended from May 1 to August 31.

Might the Biden administration extend the deadline once more? It might. After all, midterm elections are in November, so another extension is certainly a possibility. In June, US Education Secretary Miguel Cardona noted that another extension “could” be coming. President Biden has also suggested that a seventh extension might occur, saying last month that the matter was “on the table.”

It is also possible that Biden might offer an across-the-board reduction in loan balances of $10,000 per borrower (provided annual income is less than $150,000). On top of this, there is pressure from Senate Majority Leader Chuck Schumer (D-NY) and others to cancel $50,000 of debt per borrower, while activist groups like the Debt Collective argue for full debt cancellation.

While much can change between now and the end of August, the prospects for across-the-board debt cancellation remain uncertain, and the August 31 date to resume loan payments looms large. How does a borrower prepare for the possibility that payment will soon resume?

The quick answer is that there are some things student loan borrowers should do to at least prepare the possibility. One added wrinkle: loan servicers are changing. If you are one of the 45 million-plus Americans with student loan debt, to check on who is servicing your account, you can go to your federal loan page’s payment history, enter “all” in the timeframe, and print the history out. While there is no across-the-board cancellation of school loans to date, it appears that the Biden administration and US Department of Education are putting a foot in every door of the student loan programs and policies.You may also be able to export your payment history to spreadsheet software, which is a good idea. As servicers change, borrowers need to ensure that their payment history is moved to the new servicer’s platform correctly.

Only a short time is left to prepare to resume making payments for those who haven’t been paying during forbearance. And only a short time remains to make a payment or two that will go entirely toward the principal without the crush of interest.


The Promise of the New Regulatory Framework

While there is no across-the-board cancellation of school loans to date, it appears that the Biden administration and US Department of Education are putting a foot in every door of the student loan programs and policies, hoping to pry open some room to allow—in even the smallest of ways—release from crushing debt for student loan borrowers. The proposed regulation changes were released on July 6, and shortly after the proposed rule is published in the Federal Register, a 30-day comment period will commence. Those comments will be considered and edits made, and the rules will be published in the fall. The Biden administration aims for the new rules to take effect by July 1, 2023.


Limiting Accumulated Interest

In the student loan program, it is often easy to qualify for forbearance. For example, imagine a parent who has a child and leaves the workforce for a few years. The person is not earning income and therefore is granted forbearance. With forbearance, payments are suspended. However—except for the current payment freeze period—typically, interest still accrues when a loan is on deferment or forbearance, and that interest is capitalized, meaning it is added to the principal amount of the total student loan debt. When payments resume, a borrower might find that their loan balance is far greater than it was when that person graduated from college.

There is a better option for these borrowers—namely, income-based repayment plans that might require a “zero” payment and don’t accumulate interest—but for-profit servicers often steer borrowers into the much higher cost forbearance option. As attorney Adam Minsky explains, “Millions of borrowers were improperly steered into forbearance, rather than an income based repayment plan, causing them to lose months or years of progress towards student loan forgiveness.” In other words, millions of borrowers—Minsky estimates at least 3.6 million Americans—owe thousands or even tens of thousands more than the law says they should.

Stacey Cowley of the New York Times contends that fixing this is “the most far-reaching move” of the new rules. At some level, it would “affect nearly all the tens of millions of people with federal student loans by limiting interest capitalization—which adds unpaid interest to the borrower’s principal, compounding the total amount owed. Under the Biden administration’s proposal, interest would no longer be capitalized when a borrower either starts repaying or defaults on a loan.”

Writing in the Washington Post, Danielle Douglas-Gabriel explains that, according to US Education Department survey data, “27 percent of people who started college in 2003-04 had a larger principal balance after 12 years than what they originally borrowed. Black borrowers and those from low-income households were overrepresented in that group.”

It’s worth emphasizing how common forbearance is. Douglas-Gabriel reports that according to the same study, prior to 2020, half of all surveyed white borrowers had spent some time in forbearance, 59 percent of Latinx borrowers, 64 percent of Native American borrowers, and 80 percent of Black borrowers.


Changes for Existing Forgiveness Programs

Borrowers in current forgiveness programs should have been informed in the months since October 2021 about the waivers now in place that eliminate differences in repayment plans, such as those of income-driven plans like Income-Based Repayment (IBR) and Pay as You Earn (PAYE).

All payment plans now qualify towards forgiveness programs such as PSLF. Servicers do warn that if your account hasn’t been updated yet to show the waiver inclusions, it can take several months. The new regulations have made other adjustments to the limited PSLF waiver: late payments, lump payments, and partial payments will count towards PSLF payment count; and for those who made payments on a Federal Family Education Loan Program (FFELP) before consolidating their loans, those payments will also count. Borrowers still on FFELP can consolidate now and apply for PSLF by October 2022 if their employment qualifies.

One additional positive note: The US Department of Education has determined that for those who qualify for the PSLF program, the 30 months for which payments have been frozen due to the pandemic will count toward the required 120 payments in PSLF. Service in the Peace Corps, AmeriCorps, National Guard, and military will count towards PSLF payment time, too.


Colleges That Lied or Closed

The proposed regulations would allow borrowers who had been deceived to file group claims, loosen time limits when borrowers can file the claims, and broaden the types of wrongdoing to include things such as deceptive recruitment practices. Colleges will be prohibited from requiring student borrowers to sign class-action waivers or pre-dispute arbitrations agreements. If a college closes, students are often left with loans for something they did not receive. Loans will be automatically discharged for borrowers who enrolled within 180 days of closure and did not finish their education at that school or at another within one year of the initial college’s closure.


Special Note for Income-Driven (IDR) Plans 

Students in IDR plans must certify their income annually for the servicer to calculate monthly payment amounts. This was paused with the pandemic-period loan forbearance. Borrowers must recertify in March 2023. If there has been a change in income, borrowers can self-report before the end of February 2023 on the IDR Plan Request form. After March 2023, borrowers will not be able to self-report their income. The Free Application for Student Aid (FAFSA) form already accesses IRS 1040 filing for income data.


Forgiveness and Taxes

To date, according to the US Department of Education, the Biden administration has already approved nearly $26 billion in student loan relief for more than 1.3 million borrowers through executive action. While this is a small sliver of the $1.73 trillion balance (about 1.5 percent), it is nonetheless highly significant for the borrowers affected. It includes:

  • Approximately $8 billion through borrower defense (ie, cases where a college has been found to have misled borrowers)
  • Nearly $9 billion to borrowers who have permanent disabilities
  • More than $8 billion to borrowers through the PSLF program
  • Over $1 billion in closed school discharges

One important note: according to past tax rules, student loan cancellation can sometimes be considered “income” and therefore can result in an unwelcome income tax liability surprise. Historically, some loan programs such as PSLF provided loan forgiveness tax free, but other programs did not. The American Rescue Plan temporarily exempts all federal student loan cancellation through 2025 from income tax, but with a few provisos. This is something to be aware of and might require advice from a tax professional. In the meantime, President Biden is seeking congressional legislation to make forgiveness under IDR payment plans permanently exempt from taxation.


Unwinding the Student Debt “Monster” 

As noted above, the entire federal student loan edifice remains opaque. Cleaning up the mess is a complex, multifaceted endeavor.

In an interview months given before her passing in 2019, Alice Rivlin, the famed economist who as an aide to President Lyndon Johnson authored a proposal—published in January 1969—that helped to create the federal student loan program, explained the program’s initial logic: “It evolved into an almost fixation—among economists anyway—with the idea that higher education added to your future income and therefore loan finance was a sensible thing. You could pay it back out of your future income. Companies can borrow to buy equipment. People ought to be able to borrow to invest in themselves.”

But the system was built to fail. Colleges had an incentive to raise prices and encourage students to take on loans to cover the costs. And there was plenty of room for profit to be made by firms that encouraged students and their families take on more debt. Asked by a Wall Street Journal reporter to comment on her work 50 years later, Rivlin was devastating in her assessment, “We unleashed a monster,” she remarked.