Minimizing Your Student Loan Cost May Be More Complicated Than You Think

Beyond the Headlines: Personal finance news and research you may have missed

Beyond the Headelines

You’ve probably heard about all the shortages lately and how they seem to be driving prices higher and higher. Gas has been harder to find because a major pipeline had to be shut down, the scarcity of lumber continues to push new home prices higher, and a shortage of semiconductors is really creating some sticker shock on the used car lot

This shortfall of supplies is holding back businesses and stunting job growth too. Even workers to fill job openings seem to be pretty scarce, prompting Red and Blue politicians to take different approaches to solving the problem. Taken together with the level of demand—increasing as vaccines conquer the pandemic—and it’s no wonder the inflation rate in April jumped the most in 12 years

But here’s what you may not have heard, especially if you were preoccupied with your shrinking buying power: Did you know that the best way to minimize student loan costs isn’t as simple as you might think? Or that Federal Reserve Chair Jerome Powell’s voice typically shows less positive emotion at press conferences than either of his two predecessors?

To reach beyond the biggest headlines, we scoured the latest research, surveys, studies, and commentary to bring you the most interesting and relevant personal finance news you may have missed.

What We Found

Digging Out of Student Debt May Be More Strategic Than You Realize

The crushing burden of student loan debt in the U.S.—$1.7 trillion by a recent count—has some politicians proposing that the government just push a button and wipe out a set amount (which may amount to all of it) for each federal loan borrower.  

In the short term, pandemic relief measures from the government mean that borrowers with federal student loans can take an interest-free breather from paying loans through September. But in the long run, with any student loan cancellation uncertain at best, borrowers will have to figure out how to dig themselves out of the hole. 

What’s the best way to do that? A team of mathematicians in the U.S. and Ireland crunched the numbers and found there’s more than meets the eye when it comes to repayment options. One option is to enroll in an income-based repayment (IBR) plan, where payments are based on your income and family size, and are therefore more affordable and flexible than a standard repayment plan. After 20 or 25 years, depending on the plan, the remaining balance is forgiven.

But IBR plans can be a double-edged sword, not only because of the interest cost associated with paying a balance more slowly but because forgiven loan balances are typically taxed as income, meaning there will be a large bill at the end of the repayment period, the researchers wrote in an April issue of the SIAM Journal on Financial Mathematics. (Recent legislation actually makes any loans forgiven in the next five years tax-free, but who knows what the status will be after that.) 

Under a mathematical model developed by the researchers, the best strategy for keeping your overall cost of borrowing down actually depends on the size of the loan: For a small loan, it’s best to pay it off as quickly as possible as opposed to enrolling in an IBR plan. For larger loans, however, the optimal strategy is either an IBR, or, in some cases, a period of aggressive payments and then IBR.

Here’s an example they offer: A dentist with a $300,000 student loan would pay $512,000 over the life of the loan by paying it off aggressively, contributing 30% of his income above subsistence. The same loan would cost $524,000 if the dentist goes with an IBR scheme immediately after graduating, paying only 10% of that discretionary income. 

But, the best-case scenario is making the 30% payments for 8.5 years and then switching to income-based repayments. In that case, the loan would only cost $490,000—$34,000 less than if the dentist immediately enrolls in an IBR and $22,000 less than if he doesn’t enroll in an IBR at all. 

The article doesn’t specifically quantify large versus small loan balances, though it does say other debt like mortgages or car loans should be taken into account, including how expensive those are versus the student loans. It also, unfortunately, doesn’t give layperson’s instructions for making such calculations, although the authors do seem surprised that a debt burden linked to delaying things like marriage and homeownership would be so understudied.

“Despite the popularity of student loans, the problem of finding the cost-minimizing repayment strategy does not seem to have been considered and solved in detail before,” they wrote.

A Low-Income Tax Break’s Surprising Downside: Lower Wages

One of the pillars of President Joe Biden’s American Families Plan is extending an expansion of the Earned Income Tax Credit (EITC), a perk aimed at encouraging low income-earners to join the workforce. During the pandemic, the maximum value of the credit for childless workers was nearly tripled to $1,502, and income and age requirements were loosened—changes that Biden has proposed making permanent. But the tax credit may in fact be a mixed blessing for the workers it’s intended to help, according to research from The New School in New York, published as a working paper in March. 

By expanding the labor supply, the credit works to drive wages down for those without college degrees, and may have a negative impact on workers who are ineligible for the credit or who don’t know about it, the researchers said. They used U.S. Census data to look at the EITC’s effect on job turnover and wages over time, comparing states that have added their own supplements to the federal EITC to those states that didn’t.

Between 1991 and 2019, wages stagnated for younger non-college-educated workers in states with generous EITC supplements, while those in states without such supplemental EITC benefits saw their wages grow 5.3%. For older non-college-educated workers, wages during that period actually decreased by 3.1% in the generous states, while they rose by 9.2% in the non-generous ones, according to the New School analysis. That’s because with the EITC encouraging more people to work, employers don’t have to compete as much on wages to attract workers. 

“Increasing the generosity of EITC stunts wage growth for workers without college degrees,” the researchers concluded, suggesting that the government could offset this negative impact by increasing the federal minimum wage. 

The researchers also recommended expanding the credit for childless workers and including workers under 25 and over 65—exactly as was done for one year in the American Rescue Plan relief bill.

Minority-Owned Small Businesses Face Uphill Battle for Financing

Economists continue to discover ways in which the economic deck is stacked against minorities. A recent analysis by real estate firm Redfin, for example, showed that homes in Black neighborhoods are routinely undervalued, going for $46,000 less just for being located in a Black community rather than a White one. 

Now, in an April report from the New York Fed, there’s new evidence of racial disparities, this time when it comes to Black and Latino-owned businesses borrowing money. A survey, conducted by all 12 Federal Reserve banks, polled more than 9,600 employers with less than 500 workers in September and October 2020 and found that White-owned businesses were at least twice as likely to get the financing they needed.

Among Black-owned small firms that sought out non-emergency loans in the previous 12 months, 13% said they received all the funding they sought, compared to 20% of Latino-owned businesses and 40% of White-owned businesses. 

Even among firms with good credit, 48% of White-owned businesses received all the funding they sought, compared to just 24% of Black-owned and 25% of Latino-owned businesses.  

Among its other findings: 43% of Black-owned businesses reported receiving all the money they sought from the government’s COVID-19 relief Paycheck Protection Program, compared to 79% of White business owners. And 38% of Black business owners borrowed money from family or friends, compared to just 18% of their White counterparts.

“Prior to the pandemic, small businesses owned by people of color, in aggregate, faced greater challenges than white-owned firms,” the report said, and the survey “provides evidence that the pandemic exacerbated those challenges.”

Tone Matters, Especially if You’re Powell or Bernanke

When the chair of the Federal Reserve speaks, the stock market listens. For example, equities surged briefly at the end of April after the Fed reiterated that it was in no hurry to back off from its easy money policies despite signs of inflation. 

But what if the key to the financial world’s reaction is not only what the Fed chair says, but how they say it? Researchers at the University of California, Berkeley and in Britain, using machine learning, have found that positive tone in the voices of Fed chairs leads to “statistically significant and economically large increases in share prices.”

Focusing purely on tone of voice rather than what was being said, the researchers used a machine learning program that could recognize emotions from voice variations, and applied it to answers that Fed chairs gave during the press conferences that followed meetings of the Federal Open Markets Committee

Press conferences, as opposed to prepared speeches, were thought to be a good proving ground for testing the impact of tone of voice because that’s when Fed chairs go off script to answer questions from reporters. The researchers fed their AI program press conferences by Fed Chairs Ben Bernanke, Janet Yellen, and Jerome Powell between 2011 and 2019.

Of the Fed chairs, Bernanke had the most positive emotions in his voice, followed by Yellen and then Powell, the researchers said. Merely switching tone of voice from negative to positive could increase S&P 500 Index returns by 2%—a significant effect on the stock market—although researchers note that bond traders seem to be unaffected by such vocal nuances. 

If the paper is correct, it might be time for policymakers to rethink what attributes to look for in a Federal Reserve chair. 

“It appears that a certain level of acting skill may be helpful to ensure that the public receives the policy message fully and correctly,” the researchers wrote.