Federal Student Loan Debt Forgiveness: A Test for Credit Unions

President Biden’s plan to forgive up to $20,000 in federal student loan debt next year will provide relief to about 27 million Americans — and some of them might be at a credit union near you.

The extent of the benefit is wide, and it raises questions about how the lightening of balance sheets for millions of Americans will affect their ability to repay other existing loans and their capacity to borrow for other needs. And how might it affect inflation/?

The White House announced Wednesday it would forgive $10,000 in federal student loan debt for people who earn less than $125,000 per year. Those who fall under the income ceiling and who received a Pell Grant could qualify for an extra $10,000 in cancellation.

Biden’s announcement will also set off a test of how well credit unions are using data analytics to know their members.

Kevin King, vice president of credit risk and marketing strategy at LexisNexis Risk Solutions, said reducing student debt by $10,000 should improve consumer credit quality for many consumers. It will also mostly improve the standing of young, near-prime and sub-prime consumers and should give banks more clarity on the question of whether student debt payments would ever be restarted, after the COVID-19 pause, which Biden extended to Dec. 31.

King, whose company sells data analytics services, said it would behoove credit unions to figure out who the debt forgiveness benefits, by how much and predict what those members might be inclined to do next.

The Department of Education estimated that 43 million American would qualify for some relief and about 27 million borrowers will be eligible to receive up to $20,000 in relief, “helping these borrowers meet their economic potential and avoid economic harm from the COVID-19 pandemic,” a White House news release said.

The department estimated about 20 million borrowers will have their federal student loan debt wiped clean.

The White House said the Department of Education will have applications ready by year’s end. The debt relief will not be treated as taxable income for the federal income tax purposes.

It said more information on claiming relief will be available to borrowers in the coming weeks. Borrowers can sign up to be notified when this information is available at StudentAid.gov/debtrelief.

Federal Reserve Bank of New York researchers said in an April 21 article that forgiveness of $10,000 per borrower would “forgive a total of $321 billion of federal student loans, eliminate the entire balance for 11.8 million borrowers (31.1%), and cancel 30.5% of loans delinquent or in default prior to the pandemic forbearance. Under this policy, the average borrower would receive $8,478 in student loan forgiveness.”

King said the debt forgiveness will provide an opportunity to credit unions that are prepared, and for those credit unions that have financial inclusion strategies, it will be a test of their ability to execute on them.

“This is very targeted at helping those in middle and lower incomes,” King said. Most people graduate from a four-year college with about $25,000 debt. Chopping off $10,000 to $20,000 of that debt is “a huge relief for them.”

He added, “The critical questions that lenders will be asking focus on their ability to see and capitalize on the improvement in consumer credit quality. Will the improvement in consumer credit quality be fully reflected in traditional credit scores?”

King said the forgiveness raises the question of whether credit unions should re-double financial inclusion efforts and consider offering more entry-level financial products targeting young and near-prime consumers.

For some people benefitting from the forgiveness, it might just mean a newfound ability to open a checking account.

For others it might be the ability to take out an installment loan, get a credit card or qualify for a lower-cost auto loan.

For some, it might mean they are able to afford their first home.

However, King said the challenge for credit unions will be the extent they can identify which members benefit, how much they benefit and having products to help them in their next financial steps.

If credit unions are waiting for people who have FICO credit scores of at least 725, this loan forgiveness program won’t help them much.

But if credit unions are ready to help people climbing to a 650 credit score, many of their members will be in that category.

His company offers data that allows lenders to get a more complete view of borrowers, especially those who might not have a credit score or whose credit score underestimates their credit quality.

CU Times wants to know how the loan forgiveness plan affects credit unions and their members. Please email jduplessis@cutimes.com. Questions include:

• How many members do you estimate are affected?
• How much of an impact do you expect this will have on credit scores?
• How much of an increase in loan demand do you expect from student loan forgiveness, and in what areas?
• Do you expect the student loan forgiveness to cause a meaningful increase in inflation? How much of an increase?
• What other impacts do you foresee?