How to Use the New Student Loan Plan to Improve Your Financial Picture

Are your student loans being forgiven—or your interest rate cut? See how the new student loan forgiveness program could benefit your bottom line.

graduation caps on stacks of money
Photo: Cogal/Getty Images

About 43 million Americans are saddled with student loan debt. And with compounding interest and low, income-based payments, many of them have found themselves paying thousands more than their original student loan amount, yet making little headway at paying off the original loan.

Since the beginning of the pandemic, the government has put a freeze on student loan payments and charging additional interest on student loan balances, which has helped many people stabilize their finances a bit. But this week's announcement of a new student loan plan could help many of those families get a big step closer to a more stable financial picture.

"This is a huge first step," says Stefanie O'Connell Rodriguez, host of Real Simple's Money Confidential podcast. "This enables money for a down payment on the house, it enables people to take risks, start businesses, have families." And it could be a big step forward for you, if you are currently in the process of paying off federal student loans.

New student loan rules 101

The student loan plan is still taking shape and may be subject to some changes over the next few months, but here's what was proposed this week. Keep in mind that these only apply to federal student loans—private loans are not subject to these new rules.

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Forgive up to $20,000 in student loans

The big headlines have been all about the student loan forgiveness—$10,000 of federal student loan debt for people who make less than $125,000 as a single tax filer, and $250,000 as a couple. The loan forgiveness amount increases to $20,000 if you were eligible for Pell grants when you were in college—a move intended to target relief toward lower- and middle-income families.

And if you've made any payments on your student loans between March 2020 and now that brought you below the $10,000 or $20,000 level, you can get those payments refunded to you.

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Pay your interest on income-based loans

As long as you're making your income-based student loan payments, the government will cover the unpaid monthly interest, to help ensure that the debt doesn't snowball as you're paying it off.

"Some current and most future borrowers will greatly benefit from the changes to interest accrual," says Lauren Anastasio, CFP and director of financial advice at Stash. "Stories of interest accrual outpacing payments and responsible borrowers watching their debt grow, despite disciplined on-time payments, should be a thing of the past. This will ultimately make the prospect of borrowing less daunting."

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Reduce income-based payments

If you're on an income-based repayment schedule, the amount you are required to pay has dropped from 10 percent of your discretionary income to 5 percent, and the threshold for how much income is considered "discretionary" has been raised to help reduce the required payment as well.

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Forgive loan balances earlier

A federal student loan balance can be forgiven after 10 years of steady payments, rather than the current 20 years.

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Easier loan forgiveness for public service workers

An existing program to forgive student loans for people who work in the public sector, like teachers, firemen, and nonprofit employees, was often difficult to apply for—and kept many who qualified from taking advantage of it. The new rules simplify the process for people to apply and receive loan forgiveness.

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Continue the student loan pause until 2023

Student loans have been frozen throughout the pandemic, and the pause has been extended until the end of 2022 to allow time for the new plan to be implemented.

How student loan relief can improve your financial picture

For many Americans, the new student loan plan could make their financial future a whole lot rosier. "The changes to federal student loans may allow families to prioritize their financial goals differently," Anastasio says. "With lower levels of interest accrual, aggressively paying down these loans may become less of a priority, freeing up more cash for other goals like saving for a home or starting a family, paying off other debts, or investing."

But what should you do first if you're benefiting from the new rules? Here's what financial experts recommend.

Hold off a bit on making any big changes

While the news may have you trolling Zillow for your first house or shopping for a new EV, but it may be best to err on the side of caution for the moment. "It's not totally clear exactly what the impact is, since it's likely to be legally challenged," O'Connell Rodriguez says. "I wouldn't spend the money before I saw it reflected in my account balance."

You'll definitely want to watch for news on the progress of this plan. "For most borrowers, the forgiveness will not be automatic, so you may still need to keep tabs on when an application process becomes available and apply for the forgiveness.

Create (or boost) your emergency fund

With a recession potentially on the horizon, it pays to have money saved in reserve—at least enough to cover three to six months of expenses. "You can pad your emergency savings while you wait and see what happens with the student loans," O'Connell Rodriguez says.

Pay off high-interest debt

If you're no longer saddled with federal student loan debt, it's time to focus on any other high-interest loans you've taken on, such as credit card debt or private student loans.

If your private student loans are still an issue, consider giving your lender a call. "The best action is to be proactive," O'Connell Rodriguez says. "If your debt payments are more than you can afford, call your lender and try to negotiation with them. It's always worth a conversation, even if you aren't successful."

Start (or boost) your investing

"If you were spending $300, $800, $1200 on student loan payments and you already built that into your budget, don't take that line item out of the budget," O'Connell Rodriguez says. "Redirect that line item to continue building wealth." Your 401K or IRA is the optimal place to put that money, to help you shore up your retirement.

Start saving for milestone goals

If marriage, a new house, a new baby, or another big milestone is in your future, the student loan forgiveness could speed up your timeline for your big life goals.

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