Forget about taking out that private student loan.
With millions of student loan borrowers still drowning in debt, the student loan crisis remains one of the United States’ most critical financial issues — especially since economic experts say the nation is on track for one “whopper” of a recession in 2023, per CNBC. “There's about $1.8 trillion of student loan debt,” Sabrina Calazans, outreach coordinator at the nonprofit Student Debt Crisis Center, tells Elite Daily. There’s clearly a problem, so here’s what you need to know about how your student loans may affect you during a recession, according to the experts.
Recessions are a period of economic downturn, generally marked by furloughs, pay cuts, layoffs, and a widespread decline in economic spending. According to Vivian Tu, former Wall Street trader and current personal finance guru as Your Rich BFF, they can be triggered by several factors. “Recessions are typically caused by a world event, increased interest rates, a stock market crash, falling housing prices, [and more],” Tu says. “Think of it like a series of dominoes, one event impacts another, and another, and another until the economy sees a downturn.”
During a recession — in which many people may see troubled finances anyway — the added burden of student debt can feel even heavier. Around 45 million people have federal student debt, per NBC, and it has a disproportionate impact on families and communities of color. One-third of Black families and one-fifth of Hispanic families hold student debt. In August, the Biden administration announced a debt cancellation plan that it said would erase the debt of around 20 million people in the United States, which will work toward alleviating the student loan crisis. But Calazans also points out that about 23 million borrowers are still going to have to carry the weight of student debt. For those borrowers, Calazans says, “It's a drop in the bucket, and they're still going to be affected by it, and [have] to make those tough decisions.”
How does a recession impact your student debt?
While dealing with student debt is already hard enough, during a recession, it’s even harder. While recessions don’t automatically trigger, say, a change in interest rates or forgiveness policies once a “recession” is officially declared, the existing conditions around debt and finances in general can have a big impact. “This debt is impacting people's decisions to buy a home, buy a car, get married, start a family, [and] start a business,” Calazans says. “It's really holding people back from living and pursuing the American dream.” For example, after the massive collapse in home prices during the 2008-2009 Great Recession, student loan defaults rose by about 30%, per a 2018 study published in the Journal of Financial Economics.
While there’s no way to predict exactly how a recession may impact factors like interest, inflation, and default rates, there may be a silver lining: according to Investopedia, interest rates typically decline during recessions. To add to that, the COVID-19 recession has brought on lower interest rates and reduced payments on student loans. With the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020, interest rates on federal student loans were officially set to 0%, and federal student loan payments were altogether paused — which means as of September 2022, borrowers haven’t accrued or had to pay down interest on their student loan debts in over two years. Payments, however, are scheduled to resume in January 2023, with interest rates varying from borrower to borrower, depending on their financial standing.
How to deal with your debt during a recession
Keep making payments.
“Student loan debt is different from any other debt in America,” says Calazans. She explains how, unlike mortgages and the majority of consumer loans, student loan debt can follow you for the rest of your life. Additionally, this kind of debt can be harder to manage: interest rates are typically higher than fixed-rate mortgages, refinancing your loan through a private lender is risky, discharging student loan debt through methods like bankruptcy is almost impossible, and there’s not much recourse on predatory student loan servicing. That means student debt can be more of a burden than other kinds of debt in times of economic hardship.
“If you don't make your payments, you'll go into default,” Calazans adds. “Your wages will be garnished; your Social Security will be garnished; your income taxes will be garnished,” she says.
Unless, of course, you can make student loan $0 payments.
“With IDR, income-driven repayment, you would pay based on what your income is,” says Calazans. The IDR program takes your annual salary into consideration, and it doesn’t affect your interest rates, “so if you are not making money, if you're unemployed, you can have a $0 payment.” If that sounds like a good option for you, you may be eligible to enroll in an IDR plan by applying through the Department of Education’s Federal Student Aid site here.
However, since IDR plans extend your loan payment period from around 10 years, on average, to around 20 to 25 years, more interest will accrue on your overall balance with time. So while this route isn’t an end-all solution when it comes to affordability, it’s still safer than going into forbearance (aka temporarily pausing or reducing your payments), which can lead to consequences like accrued interest, tanked credit scores, and more. “It's a good thing that you're in IDR because then your credit isn't going to tank, you're not in default, you're not having your wages garnished,” Calazans says.
Figure out if you qualify for forgiveness or cancellation.
Many borrowers are sure to feel some relief with the Biden administration’s three-part debt cancellation plan, which went live on Oct. 17 and expires on April 30, 2023. To apply for student debt cancellation under Biden’s plan, you can fill out an application on the U.S. Department of Education’s Federal Student Aid site.
Additionally, if you work for a nonprofit, the military, or the federal, state, tribal, or local government, you could be eligible to have all of your student loans forgiven through the Public Service Loan Forgiveness (PSLF) program. Plus, until Oct. 31, borrowers will be allowed to receive credit for past payments that did not previously qualify for the PSLF program. To find out if you’re eligible, you can visit PSLF.gov to learn more and apply as soon as you’re able.
Prepare your existing finances for a recession.
Tu recommends bolstering your rainy day fund, if you have one, by putting it in a high-yield savings account. That way, as interest rates rise, so will the savings in that account. “It's an easy way to make your savings work harder for you, risk-free,” Tu says. Next, she recommends staying away from accruing risky debts. “Avoid high-interest-rate debt even more than usual,” she adds. That means you can forget about taking out any private student loans, which are notorious for hiking up their interest rates over time.
Finally, Tu encourages refreshing your resume, staying open to unexpected career opportunities, and taking control of the conversation when it comes to your finances. “During a recession, talking to your friends about money is all the more crucial,” she says. “What a lot of young people forget is that they think they're the only ones struggling. Talking about these issues will help remind you that you're not alone!”
Even in times of overall economic prosperity for the United States, student loan debt is still a heavy weight to carry — but it doesn’t have to completely control your financial well-being, even during a recession.