What is the impact of Biden’s student loan forgiveness plan?

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President Joe Biden recently announced a sweeping package of student debt relief that forgives as much as $20,000 in loans for some recipients. Biden also announced a four-month extension of the moratorium on federal student loan repayments. The plan also calls for a new “income-driven repayment” (IDR) program that caps repayments at 5% of their monthly income for undergraduate loans.

“Some previous third-party analysis ignored the fact that some borrowers with student debt already participate in existing income-based repayment programs,” says Kent Smetters, Wharton School professor and Penn Wharton Budget Model faculty director. “That analysis tended to overestimate the cost of loan forgiveness. Some previous analysis went the opposite direction and assumed full participation in existing programs when qualified, causing them to overestimate the amount of forgiveness going to high-income borrowers. The actual data falls in the middle.”

Laura Perna, Penn’s vice provost for faculty and an expert in college access, affordability, and success, especially for low-income, first-generation, and nontraditional students, says the plan recognizes the importance and value of higher education to individual participants and to communities, states, and the nation.

“Biden’s plan acknowledges that, in order to participate in higher education, increasingly students and their families need to use loans to pay the costs,” says Perna, also the Graduate School of Education’s Centennial Presidential Professor of Education. “It also recognizes that loans ‘pay off’ for many borrowers—but not all. Many students who borrow successfully complete their degrees in a timely manner and obtain a job with earnings that enable them to easily repay the loan. But, other students who borrow experience challenges. Not all students who enroll complete a degree. Not all students who finish get a job with the earnings that enable them to easily repay the loan. Challenges of enrollment, completion, employment, and repayment have been exacerbated by the pandemic.”

Under the plan announced on Aug. 24, $10,000 in federal student loan debt for those with incomes below $125,000 a year, or households that earn less than $250,000, will be erased. The plan also cancels an additional $10,000—for a total of $20,000 in cancellation—for those students who received federal Pell Grants to attend college. The cancelation applies to federal student loans used to attend undergraduate and graduate school, along with Parent Plus loans. Current college students qualify if their loans were issued before July 1.

“We estimate the program will cost about $605 billion over 10 years,” Smetters says. “However, total plan costs could exceed $1 trillion depending on future details of the income-driven repayment program. There would be almost no downside for virtually all students to participate in the new IDR and to even to take on more debt than before.”

The Penn Wharton Budget Model also estimates that about 75% of the loan forgiveness will accrue to households making less than $88,000 per year. More than 40 million Americans could see their student loan debt reduced or eliminated.

“Our previous analysis showed that a lot of the student loan cancellation did not target lower income households,” Smetters says. “However, the subsequent addition of the Pell Grant bonus of an additional $10,000 now tilts things more in that direction. At the same time, it still does not target lower income households as closely as the Earned Income Tax Credit.”

Most people will need to apply for the relief. The Education Department has income data for a small share of borrowers, but the vast majority will need to prove their incomes through an application process. Officials say applications will be available before the end of the year.

“Of course, borrowers will need to sign up if the Department doesn’t already have their information to take advantage of the forgiveness,” Smetters explains. “However, almost all experts expect a much higher takeup rate relative to existing programs with debt relief.”

Perna points out that this loan relief does not solve other issues pertaining to college affordability. “The costs of attending college are rising, and unless something else changes students and families will likely need to continue to borrow to pay costs into the future,” she says.

However, the most important takeaway, according to Perna, is that the plan offers needed debt relief that is targeted to borrowers with financial need for the relief. And, for future borrowers, it promises to address problems with current income-driven repayment plans and the Public Service Loan Forgiveness program. She explains the next best step is, “to ensure smooth implementation of these initiatives,” to ensure that eligible students and families receive the benefits.