By Leslie Albrecht Quentin Fottrell
Financial advisors explain what to do if your $10,000 or $20,000 federal student loan debt is forgiven and what you should NOT do
President Joe Biden made a long-awaited announcement in August that people earning less than $125,000 a year would be reimbursed $10,000 in federal student loans, but that would increase to $20,000 if they received Pell Grants at the university. Additionally, he said people with undergraduate loans would also have a payment cap of 5% of their monthly income.
More than 45 million borrowers owe $1.6 trillion in cumulative student loan debt. The White House said it was “a significant burden on America’s middle class. Middle-class borrowers struggle with high monthly payments and bloated balances that make it harder for them to build wealth, like buying homes, saving money for retirement, and starting small businesses.”
Some borrowers have been putting money aside since the start of the pandemic-related student loan payment pause because they expected to pay a lump sum on their loans once payments resumed, Grant Meyer said, certified financial planner and founder of GTS Financial in Bloomington, Minn. For those who qualified for forgiveness, it was a win-win.
Still, Biden’s announcement was far from a blanket cancellation. About 20 million people, mostly low-income borrowers, will have their student debt eliminated following the White House announcement on Aug. 24. That should make a difference: The Federal Reserve reports that the average student loan debt per borrower is $39,351, while the median student loan debt is $19,281.
“Black and Hispanic borrowers are significantly more likely than white borrowers to be behind on their loans, and are less likely to have fully repaid their loans,” the Fed said, adding, “The debt burden of unmanageable student loan may be of greater concern, on average, among black or Hispanic individuals than among white individuals.”
According to a recent University of Pennsylvania study, the lion’s share of federal student loan forgiveness will impact people earning well under $125,000. This study undermines the argument that millions of wealthy graduates stand to benefit the most. In fact, Penn says 74% of the rebate will affect households earning less than $82,400 a year.
Here’s what the experts say you should do next:
Invest, invest, invest
Those who qualify for Biden’s federal student loan forgiveness plan can now use that money for other purposes. Meyer recommends investing, especially given the market’s bearish trajectory over the past year. “[Withthestockmarketbeatdownsomuchthisyearit’sagreattimetopracticetheage-oldwisdomof’buylow'”hesaid[Aveclemarchéboursiertellementbattucetteannéec’estlemomentidéalpourmettreenpratiquelasagesseséculaired'”acheteràbasprix””a-t-ildéclaré[Withthestockmarketbeatendownsomuchthisyearit’sagreattimetopracticetheage-oldwisdomof’buylow'”hesaid
Jackie Fontana, CFP and portfolio manager at FBB Capital Partners, suggests investing in US Treasuries or a well-diversified equity ETF. “If they’re able to stay in the market for at least 8-10 years, go for an equity ETF. If you need access to funds sooner than that, consider buying treasury bills US, which currently yield nearly 3%.
“I’ve seen how student loan payments hinder clients’ ability to save for the long term,” Catherine Valega, certified financial planner and chartered alternative investment analyst at Green Bee Advisory in Winchester, Mass. “So I would use the cash flow to invest — whether that’s putting more into a 401(k), an IRA (Roth or traditional), or long-term taxable savings.”
“The sooner we can make the money work for us, the better off we are in the long run,” she added. A 25-year-old investing $1,000 per year for 10 years, and $2,000 per year for 10 years, and no longer contributing to a retirement account until age 65 would have $160,000, with a rate of return of 6%, according to Her Money, a personal finance site.
(Read more here from MarketWatch reporter Alessandra Malito about using the extra $10,000 or $20,000 to invest in retirement.)
Pay off that credit card debt
High interest debt will hold you back and should be paid off before it gets worse. Fontana of FBB Capital Partners told MarketWatch, “I would recommend prioritizing repayment of any high-interest credit card that carries a monthly balance,” she said. Paying only the minimum each month can prevent you from saving for a home and ultimately hurt your credit score.
There is cause for concern about credit card debt. Americans charged an additional $46 billion on their credit cards during the second quarter and their balances saw the biggest increase in more than 20 years, according to data released in August by the Federal Reserve Bank of New York. Credit card debt rose 5.5% from the first to the second quarter and 13% year over year.
Try your luck in a new job or career
Having significant student loan debt means that salary is a key factor when looking for a job, as your paycheck must cover these payments as well as your other monthly essentials. With that debt out of sight, some people can now take a chance and switch careers, Meyer told MarketWatch.
“If you had to focus only on the salary to make sure you could pay off your student loan, but you no longer have that worry, this may be a chance to pursue a dream where the focus is not -not being put on the salary as much -or starting in a different area where you will have to progress again,” Meyer added.
Accelerate the path to home ownership
A recent survey by Rocket Mortgages said nearly 70% of millennial student loan borrowers who intended to buy their first home in the next decade or so said student loan forgiveness of Biden could help shorten their purchase time by 1-3 years. The growth rate of house prices is slowing, but they peaked in April.
The rise in the S&P CoreLogic Case-Shiller house price index for 20 cities slowed to 18.6% year-on-year in June, from 20.5% the previous month. But buyers, especially younger buyers, are still facing headwinds from rising interest rates and tight supply in many areas. Analysts say there is little evidence of the kind of crisis that occurred during the 2008 subprime mortgage crisis.
Consider an emergency fund
“Start saving for emergency savings enough to cover 3 months of living expenses,” said Fontana of FBB Capital Partners. Some experts even recommend 6-12 months of living expenses for an emergency fund. “The specific approach a person should take if they have extra money in their monthly budget depends on their personal financial situation,” she added.
Graduates may feel like they have less job security with growing fears of an impending recession and a series of job cuts and job vacancies canceled by Big Tech. Even with a 3.5% unemployment rate, the specter of an interest rate hike by the Federal Reserve in an effort to combat 40-year high inflation is making workers, especially entry-level graduates, more vulnerable.
Finally, here’s what NOT to do
Don’t use the freed-up funds “for additional expenses,” said Valega of Green Bee Advisory. “It blows it up – and defeats the purpose.” This can be tempting for younger borrowers who don’t feel burdened with other debts and responsibilities. If you have emergency savings, Meyer of GTS Financial added that holding cash is not the best course given record inflation.
It’s a balance. Valega says the big worry is that people will splurge. It’s like when you get a raise at work, she says. There is a danger that the extra money could lead to “lifestyle creep” or living beyond your means. As a general rule, it is better not to increase your standard of living too much; just add the increased funds to your long-term investments, she added.
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