Biden’s plan to write off student debt may apply to billions of dollars in loans held by investors, but there’s a catch
By Joy Wiltermuth
‘Consumer finance companies are going to be all over this,’ ex-Wall Street trader says of Biden’s plan to write off some student debt
The Biden administration’s plan to forgive up to $20,000 in student debt is not limited to borrowers seeking relief on loans the government already owns.
About $110 billion in older “private” student loans created under the defunct federal Family Education Loans (FFEL) program could also be eligible, even if they are not directly eligible for tax relief. debt under President Biden’s plan, a person with direct knowledge of the matter told MarketWatch.
As long as they meet the debt relief plan’s income criteria, borrowers with FFEL loans held beyond government reach, including those who were wrapped up in bond deals years ago, can be consolidated into a new federal “direct loan” to qualify for cancellation, according to the Department.
If borrowers with these loans accept the government’s offer to consolidate to receive debt relief, it could also mean an unexpected deluge of bond payments that benefit investors.
Who owns student loans
As in the mortgage market, the US government has been the dominant player in funding student loans for decades.
With approximately $1.1 trillion from the Department of Education, the federal government owns all but a tiny slice (see chart) of the overall $1.6 trillion student loan pie.
With the government’s outsized footprint, Biden’s debt relief plan can reach most borrowers earning $125,000 or less, but not all.
Prior to 2010, banks and other private lenders were busy packaging billions of government-backed FFEL student loans each year into asset-backed securities (ABS), or bond transactions that promise to pay holders the principal and interest over a certain period of time.
Deutsche Bank analysts have estimated FFEL asset-backed bond issuance to average $6 billion a year from 2018 to 2021, with a bumper second-quarter tally of around 110. billions of dollars.
“We would expect a wave of prepayments,” Kayvan Darouian’s research team told Deutsche Bank in a weekly client note released in August, particularly if more borrowers get debt forgiveness under the framework. of the Biden plan through consolidation.
Biden’s goal is to forgive up to $10,000 for each eligible borrower earning less than $125,000 a year, or $250,000 for a married couple. Eligible borrowers who received Pell grants or need-based financial assistance would see $20,000 forfeited.
While past student loan relief programs have been difficult for borrowers to navigate and slow to take hold, the prospect of sweeping debt cancellation could galvanize households.
The FFEL ended under the Obama administration and was replaced by direct government loans, although many of the old loans under bond operations have yet to be repaid by borrowers.
Read: Biden’s $10,000 student debt relief plan could mean 15 million borrowers owe nothing
Should we consolidate?
The Consumer Financial Protection Bureau, a consumer watchdog, updated its guide for borrowers looking to consolidate their student loans in February.
Since many students take out new loans for each year of study, consolidating into a Federal Direct Loan can combine several older loans into one loan. Consolidation does not lower a borrower’s interest rate – the new loan rate is a weighted average of the loans that have been consolidated. But consolidating FFEL loans into a direct loan offers other benefits, such as making the loan eligible for certain programs, including a civil servants debt cancellation initiative. For borrowers with corporate-held FFEL loans, the consolidation will also make them eligible for the Biden administration’s broader debt relief plan.
“For the most part, this is a great opportunity for borrowers,” said Persis Yu, director of policy and general counsel at the Student Borrower Protection Center, in a call with MarketWatch.
However, there could be some potential downsides, Yu said, including that unpaid interest would roll into the balance of the new direct loan, offsetting the size of any debt forgiveness. Also, any unresolved issues with a previous lender, such as disputes over past payments, would be waived under the new loan.
Finally, borrowers owed for debt forgiveness as part of the Corinthian College settlement, or other for-profit colleges the Biden administration has said misled students might want to wait for that relief to be finalized. before consolidating, Yu said.
It should be noted that the Biden plan does not include lower student loan rates. Private lenders and many refinancing startups like SoFi Technologies Inc., (SOFI) and Earnest began refinancing student loans about a decade ago at lower rates.
These loans cannot be consolidated into a new direct government loan. However, over the next two months, the Department of Education will consult with private lenders to consider providing relief that includes such loans, the person said.
Beyond debt forgiveness, eligible borrowers might also consider the option of government consolidation as a potential cost-cutting measure if any of their student loans have a variable rate (all federal student loans taken by borrowers on or after July 1, 2006 have a fixed interest rate). The Federal Reserve plans to continue raising its benchmark rate to around 4% this year from its current range of 2.25% to 2.5% to combat high inflation.
Rate hikes make variable rate debt more expensive for borrowers and may lead to increased borrower defaults, which was a major catalyst for the subprime mortgage crisis 15 years ago .
Lenders “will monetize this”
In addition to debt forgiveness, Biden’s plan also bolsters existing income-based repayment plans for many student loans, including capping monthly undergraduate loan payments at 5% of college’s Discretionary Income. the borrower, instead of the current limit of 10%.
While more details are expected in the coming weeks, the White House said the effort would give families “breathing room” before the pause on federal student loan payments put in place at the start of the pandemic. in 2020 does not expire at the end of December.
“We still don’t know what the details look like,” said David Sacco, a former Wall Street fixed-income trader who now teaches finance at the University of New Haven. But he suspects lenders have already started preparing for customers to receive student debt relief.
“Consumer finance companies are going to be all over this,” Sacco said, adding that while Biden’s debt relief is only targeting low-to-middle income households, many will have mortgages, credit cards credit and other existing consumer debt, in addition to student loans.
“In some cases, accessing a $10,000 grant can be a significant down payment on a home,” he said.
Worries over higher BX:TMUBMUSD10Y rates and a possible US recession weighed on stocks after a brief summer rally. The Dow Jones Industrial Average, S&P 500 Index and Nasdaq Composite Index were all down Tuesday after Labor Day.
Read: Biden’s student loan forgiveness is a game-changer, but will it allow millions of renters to finally buy a home?
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