If you’re buried under a mountain of student loan debt, having it forgiven can be a huge relief. Forgiveness is generally possible if you’re disabled, part of one of the income-based repayment options or pursuing a career in public service. While getting your loans wiped out in one fell swoop can seem like a lifesaver, it may come with some negative financial implications. We cover what you need to know below. You may also want to work with a financial advisorwho can help you plan ahead for your student loans.
Student Loan Forgiveness and Your Credit
Generally, when a student loan is forgiven, it shouldn’t impact your credit in a negative way. As long as your loans were in good standing at the time they were discharged and your accounts are being reported properly to the credit reporting bureaus, you won’t see a huge difference in your score.
On the other hand, you could see your score drop if your account wasn’t in good standing prior to the discharge. For instance, if you fall behind on your loans because you become disabled, your loan servicer will report the missed payments on your credit. Once the loan is discharged the balance will show up as zero, but your lender isn’t required to remove the previous negative credit history.
If your loans have been discharged and the accounts aren’t being reported properly on your credit, you have the right to dispute anything that’s inaccurate. Thanks to a recent settlement, the credit bureaus are now more inclined toinvestigate and correct any errors in a timely manner.
Tax Treatment of Forgiven Debt
Aside from potentially damaging your credit, student loan forgiveness can complicate your tax situation. The IRS views forgiven debt as taxable income unless it meets specific exemptions or exclusions. Exceptions are made for student loans that are forgiven, but it’s only for borrowers who are participating in certain programs.
For instance, if you’re going through the federal Public Service Loan Forgiveness or Teacher Loan Forgiveness programs, you won’t have to pay taxes on anything that’s written off as long as you meet all of the requirements. On the other hand, if you’re on the Income-Based Repayment plan, the amount that’s left over after you hit the 25-year repayment mark would automatically be forgiven but you’d have to report it on your taxes.
That creates a kind of catch-22 for borrowers since you have to maintain a lower salary to stay on an income-dependent repayment plan. If you can’t pay, that opens the door to even more problems in the form of tax penalties and interest or even a lien, which can be devastating for your credit.
Other Problems With Loan Forgiveness
Before seeking forgiveness for your loans, there are a few things to keep in mind. For one thing, it isn’t guaranteed. With the Public Service Loan Forgiveness program, borrowers are required to work in public service for 10 years and make on-time payments during that time to qualify. That sounds easy enough, but since it’s a federally funded program, there’s always the possibility that it could be shut down. If that happens, you’ll still be stuck paying those loans.
The other issue is that it can cost you more money in the long term. Someone who owes $30,000 in loans with a 6 percent interest rate would have to pay about $333 a month on the standard 10-year plan and the total interest would come to just under $10,000. If you’re making $30,000 a year, you could qualify for IBR. After 15 years, your loans could be paid off, but you’ll have paid a larger amount of interest in the process. That’s something that you can’t afford to overlook.
Bottom Line
Student loan forgiveness can sound great since you won’t have to pay back the balance of what you owe. However, there could be some negative implications that end up hurting your overall financial situation. Some of these negative impacts include being taxed for the amount that is forgiven at the federal and/or state levels. Forgiveness also tends to be discussed more than it is actually given out and received by people so it’s important to know exactly what you’re getting before signing anything.
Tips for Your Taxes
- If you’re struggling to figure out how your taxes are going to be impacted by certain things, it might be beneficial to talk to a financial advisor.Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- You can also go through estimations on your own. You can read SmartAsset’s guide to taxes on student loan forgiveness to learn more.
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FAQs
Generally, when a student loan is forgiven, it shouldn't impact your credit in a negative way. As long as your loans were in good standing at the time they were discharged and your accounts are being reported properly to the credit reporting bureaus, you won't see a huge difference in your score.
How does student debt affect students financially? ›
Key Takeaways. Carrying student debt can affect your ability to buy a home if your debt-to-income ratio is too high. If you have too much student loan debt, you won't be able to save as much for retirement. Student loan debt can lower your credit score, especially if you fail to make on-time payments.
How does student loan forgiveness affect the economy? ›
Both student debt relief and SAVE will enhance the economic status of millions of Americans with student debt: enable them to allocate more funds towards basic necessities, take career risks, start businesses, and purchase homes with the understanding that they will never have to pay more than they can afford towards ...
What are the benefits of forgiving student loans? ›
Under the SAVE plan, sub-baccalaureate borrowers, similar to low-income borrowers, are likely to benefit from considerable loan forgiveness. This is driven by a greater share of income being protected – resulting in lower monthly payments, increased liquidity, and lower total payments overall.
What are the disadvantages of forgiving student debt? ›
Opponents contend that the cost of such forgiveness would be much higher than the benefit to the economy, would disproportionately benefit higher-income Americans, and would only offer a temporary reprieve before total outstanding student debt rose again.
Who is most affected by student debt? ›
Black and Latino borrowers are disproportionately impacted by student loan debt. Due to racial wealth disparities, most Black and Latino college students come from low-income backgrounds and can count on only a fraction of the financial support.
Do student loans affect debt-to-income? ›
Student loans add to your debt-to-income ratio
DTI includes all of your monthly debt payments – such as auto loans, personal loans and credit card debt – divided by your monthly gross income. Student loans increase your DTI, which isn't ideal when applying for mortgages.
What is the main cause of student debt? ›
Soaring college costs and pressure to compete in the job marketplace are big factors for student loan debt. Student loans are the most common form of educational debt, followed by credit cards and other types of credit. Borrowers who don't complete their degrees are more likely to default.
Who benefits more from student loan forgiveness? ›
Those would eliminate at least $20,000 in accrued interest for those who owe more than their original loan, offer more for those with lower incomes, cancel remaining debt for anyone who has spent 20 or 25 years, depending on the loan, repaying their loans, and void loans from college programs that were proven to be ...
Does student loan forgiveness help the wealthy? ›
Despite the Administration's attempts to target low-income borrowers, top earners will still benefit the most from Biden's student loan giveaway. Analysis from the Committee for a Responsible Budget (CFRB) found that America's highest earners will reap nearly two thirds of the giveaway.
Despite their qualifications, grads often have to settle for lower-paying, lower-skill jobs just so they can start paying their loan bills right away. As a result, graduates in debt often miss out on the benefits that come with a degree.
Does forgiving student loan debt cause inflation? ›
If the debt forgiveness program is permitted to move forward, at a time when consumer spending already is high, it could lead to more inflation, Jones said.
How student loan forgiveness could increase inequality? ›
Essentially, the research finds that forgiveness would benefit wealthier borrowers more than low- and middle-income borrowers. The authors stated that forgiveness outcomes would be uneven because “high earners took larger loans, but also because, for low earners, balances greatly overstate present values.”
What happens if you apply for student loan forgiveness? ›
If you qualify for student loan forgiveness or discharge in full, and have applied if necessary in your case, you will get a notification and will no longer need to make payments. In some cases, you may even get a refund, depending on the program you applied under.
How will I know if my student loan will be forgiven? ›
Borrowers who have reached 20 or 25 years (240 or 300 months) worth of eligible payments for IDR forgiveness will see their loans forgiven as they reach these milestones. ED will continue to discharge loans as borrowers reach the required number of months for forgiveness.
Will I get money back from student loan forgiveness? ›
If you're a longtime borrower and you get your loan balance forgiven under the IDR account adjustment, it's possible that you actually overpaid. » MORE: What happens next if your student loans are forgiven? In most cases, you'll get a refund for any overpayments beyond 20 or 25 years.
