Did Student Loan Forbearance Push Distressed Borrowers Further into Debt?

When the COVID-19 pandemic hit in March of 2020, Heather Tookes, a professor of finance at Yale SOM, began to study the impact of various government policy responses to the crisis. With colleague Matt Spiegel, she published two research papers about the effectiveness of various restrictions on businesses such as restaurants, bars, and retail stores.

As business restrictions began to lift, Tookes turned her attention to the federal student loan forbearance policies that went into effect in March 2020, pausing student loan payment requirements and lowering the interest rate on these loans to 0%. Originally intended to last just a few months, the program was extended several times and is now scheduled to end on September 1 of this year, with payments resuming in October. If the most vulnerable student loan borrowers did not have obligation to make their student loan payments, she wondered, were they saving more or spending more, and if they were spending more, was it because more credit was suddenly available to them? One of Tookes’s usual research areas is corporate finance, where she has studied the way credit market frictions interact with firms’ financing decisions. But in this case, she and her coauthors examined the credit market with a focus on individual borrowers.

With two colleagues from Georgia Institute of Technology, Sudheer Chava and Yafei Zhang, Tookes began digging into the data, which they obtained from one of the major credit bureaus. They looked at borrowers who were already in financial distress before the pandemic, which they defined as anyone with a student loan delinquency in the 24 months leading up to the pandemic. “We study this group because the goal of the policy was to help the most vulnerable at the onset of the pandemic,” Tookes says. Because the federal student loan forbearance was automatic and applied to all federally held loans, they had a natural control group of people with privately held loans, who generally had to continue paying throughout the pandemic, unless they were able to obtain forbearance from their specific lenders. Many of the privately held student loans were issued under the now defunct Federal Family Educational Loan program at similar terms to the loans issued directly from the government. The research team created a matched sample of student loan borrowers from the two groups where they paired borrowers based on credit scores, zip code, age, gender, income, loan balances, and other debt. And then they followed the numbers to see what happened over the next three years.

One of the first things that happened after forbearance went into effect was that the federal borrowers’ credit scores jumped dramatically, an average of nearly 70 points in the first year. The authors attribute 13.4 of those points to the forbearance program. Borrowers in forbearance had delinquency flags, an important factor in credit scores, removed from their credit reports. The lack of student loan payments, combined with broader COVID relief programs, including stimulus checks from the government, meant that some of these distressed borrowers suddenly had some extra money. And now they also had much better credit.

“One thing to do would be to try to put any extra money aside in some interest-bearing account until you have to start paying again,” says Tookes. “But we observed increases in credit card and auto debt. People started spending more, and the increased spending continues.”

On average, credit card borrowing increased an extra 12% for the forbearance group. Auto debt increased, too, by an extra 4.6% compared to the control group. The only kind of debt that didn’t increase was mortgage debt. Tookes and her colleagues still aren’t sure why. “One possibility is that mortgage lenders take into account information that goes far beyond a credit score,” she says. “Or maybe something about the temporary nature of forbearance made them more cautious when lending to these more vulnerable borrowers.”

Tookes stresses that the researchers made no qualitative judgments, positive or negative, about the borrowers taking on more debt or about creditors supplying that debt. Maybe people were finally purchasing items that they had been putting off because student loan payments took up so much of their monthly income.

“But what we did next and what is the most concerning part of our analysis,” she says, “was to look at the delinquencies following forbearance. Delinquencies on credit cards and auto debt are starting to rise at a higher rate for the forbearance group, even before student loan payments resume.”

The delinquencies in the non-student loans, Tookes notes, began increasing in the second year of the pandemic, approximately 16 months after forbearance first started. “Even before the requirement to start paying again,” she says, “even before turning the faucet back on, this group has more credit card debt, more auto debt, and more delinquencies, and now they’re going to have to start paying their student loans.”

What will happen when payments resume in the fall? Tookes says there’s no way to know for certain, but there may be a hint in the data from the control group. Some of those borrowers did request and receive shorter periods of forbearance from their private lenders at the start of the pandemic. But 10 to 12 months later the data show an uptick in the fraction of student loans that are more than 90 days past due, which may indicate that they had to start paying again and were unable to do so.

“Does this all mean that student loan forbearance at the onset of the pandemic was unhelpful?” she asks rhetorically. “I don’t think so. I think in the beginning there was a lot of uncertainty. We didn’t know what was happening and people were not working. The better question is whether extended forbearance, where all borrowers with federally held student loans were automatically enrolled into the program for more than three years, was helpful.”

Tookes plans to continue studying the data even after the forbearance period ends. Given her interest in the supply side of credit markets, she’s most interested in why the credit card companies and auto lenders were so willing—and are still so willing—to provide funds to borrowers whose credit reports suggested that their scores had improved due to a temporary program, rather than a shift in permanent financial health.

“We want to make sure we understand the role that policies can have in creating a situation of extra distress” she says.