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Wednesday, February 28, 2024

Why student loan repayment won’t hurt the economy


One of the concerns about the resumption of student loan payments is that it could hurt the U.S. economy. Paying back student loans can cause consumers to cut back on spending to the point where they cause this another recession.

About 43.4 million Americans have federal student loans, which collectively amount to $1.63 trillion in debt, according to National Student Loan Data.

Student loan debt represented roughly 11% of total household debt, up from just 3% in 2003, according to data from the Federal Reserve Bank of New York.

These numbers may seem like a lot, but they are not big enough to cause a significant slowdown in GDP. Oxford Economics estimates that resuming student loan payments will reduce 0.1% of GDP in 2023 and 0.3% in 2024. Other economists also estimate similar cuts.

Why student loan repayments won’t cause a recession

The last time I had a student loan was between 2003 and 2007. I took out about $40,000 in student loans to attend business school at Berkeley part time (graduated in 2006). The average interest rate was approximately 4.5%.

Even though my company paid over 80% of my school’s tuition, I still took out student loans as a way to increase my liquidity and invest. I don’t recommend this unless you are a seasoned investor.

Fortunately, the stock market was doing well until it imploded in 2008. But by then I had already paid off all my student loans.

Based on my history of student debt, I am sixteen years away from the process. Therefore, I had a blind spot about student loan repayment, which was revealed to me after a conversation with another parent.

Here are four reasons why student loan repayments won’t cause another recession. We could certainly still end up in a recession. But that won’t be the case because borrowers will suddenly have to repay their debts.

1) Borrowers have paid off their student loans

I spoke with a parent who went to medical school and is now a doctor. We talked about a possible purchase west side real estate in san francisco as I think that is where the biggest opportunity lies. He said he can’t buy real estate yet because he’s still working on paying off his student loans.

When I told him how wonderful it must have been to have their student loan payments paused, he said that he and his wife continued paying off their debt the entire time!

Ah ha! Blind spot. I had assumed that all student loan holders would stop paying back their debts starting in March 2020. When in fact, a good percentage of the 43.4 million Americans with student debt continued to pay off payments over the past 3.5+ years.

Given this is the case, the remaining payments and/or payment amounts may not be as large as many fear. After all, there was a period of over 3.5 years where student loan interest rates fell to 0%. An individual’s student debt could only have increased if he willingly took on more debt.

With more than 3.5 years of debt repayment, student loan holders have less debt today.

2) Student loan borrowers have been saving and investing their extra cash flow

Economic theory states that we are all rational actors in the long run. Therefore, so was any cash flow savings from not having to pay back student loans for 3.5 years saved or invested.

Since March 2020, the S&P 500 has risen more than 59% (2,700 to 4,300). If you have invested in real estate, your property has also increased between 10% and 60% without leverage. That’s why student loan borrowers who saved and invested their student loans are wealthier today.

Student loan borrowers who have saved and invested their extra cash flow can simply liquidate some of their investments to pay off their student loans if they wish.

Of course, not every student loan borrower has saved and invested their extra cash flow. Many people used the extra cash flow to pay for necessities or wants. But this is also an economically rational move. These people considered non-investment expenditures more important than capital expenditure.

3) The SAVE repayment plan

The Biden-Harris administration launched the SAVE Payment plan that has canceled millions of loans worth billions of dollars.

From the report: “The Biden-Harris administration estimates that more than 20 million borrowers could benefit from the SAVE plan. Borrowers can sign up today by visiting StudentAid.gov/SAVE.”

Somehow, the Biden-Harris administration has managed to cancel student loan debt despite the Supreme Court blocking Biden’s student loan forgiveness program in June 2023. Therefore, up to potentially half of all student borrowers could receive further relief.

More student debt relief through an income-driven repayment plan will soften the blow of debt repayment. As a result, consumer spending may not be as negatively affected. But undoubtedly, student loan repayments will reduce consumer spending at the margins.

4) People earn more money and are richer 3.5 years later

Are you richer and making more money today than in March 2020? Most people would say yes. Certainly, inflation of goods and services has taken a big bite out of consumers’ purchasing power. However, the majority of workers today should at least earn more.

Look at all the strikes in Hollywood, the auto industry, the media industry, the education sector, the transport sector and more. Striking workers make deals for wage increases of more than 20%.

UPS drivers make $145,000 today, but will make $170,000 by the end of 2028. Not bad!

Workers everywhere are paid more. With higher income and wealth, paying off existing student loan debt should be easier.

If you are struggling to repay your student debt

Unfortunately, all good things come to an end. Getting a 3.5 year break with 0% interest and not having to pay was a nice gift. I hope most people have taken advantage of this by putting the extra cash flow to work.

For those struggling to resume paying back your student loans, here’s what I would do.

First, go through your budget and remove all unnecessary items. Eating out, unnecessary clothing, concert tickets and vacations that require flying should all be eliminated. The joy you experience when you are 100% student debt free will be greater than the joy you experience when you spend money on indulgences.

Second, take on a challenge without spending. Make it a game and see how much less you can spend each month. Start with a total discount of 10%. Then keep cutting back 10% every month until you can’t stand it anymore. You might be surprised how easily you can adapt. Use all your savings to pay off the extra student debt.

Finally, take a sidestep and use 100% of the income to pay off student debt. Once you establish a clear purpose for your work, work becomes much more meaningful.

Don’t count on the government forever

All we can expect is more government support in the future if things get dire. However, I would try to manage your finances as if support never comes. This way you will be more disciplined with your finances. If support ever comes, the unexpected help will feel like a big bonus.

Personally, I am a big fan of paying less for education, because everything can be learned online for free. If you can’t get a large amount of scholarships, don’t go to an expensive private university. Consider one public university or community college instead of.

The problem of student debt may be too late for many of us, but it is not too late for our children!

Questions and suggestions from readers

Do you think the resumption of student loan repayments will hurt the economy? If you have had student loans since March 2020, have you continued to pay off your loans during the 3.5 year break? Are your income and assets higher today than they have been since March 2020?

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Here’s a related podcast episode about student debt, entitlement mentality, and valuing a college degree.




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