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.
Photo credit:©iStock.com/Steve Debenport, ©iStock.com/Courtney Keating, ©iStock.com/eternalcreative
FAQs
While there are few direct estimates of the effect of debt cancelation in the literature, estimates based on the relationship between wealth and consumption suggest that this forgiveness could increase consumption by several billions of dollars each year in the next five to ten years.
How does student loan forgiveness hurt you? ›
Your credit score could dip slightly
When your student loan is at “paid off” status, either through making a last payment or through debt cancellation, you could see a minor ding to your credit score.
How can student loans damage your financial future? ›
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 do student loans affect financial aid? ›
You will not get more student aid because of your debt. Using your savings to pay off your debts might improve your eligibility for need-based financial aid. Use a financial aid calculator like the one on FinAid to see if it will affect your expected family contribution (EFC).
What are the cons of student loan forgiveness? ›
5 Cons of Student Loan Forgiveness
- It Takes a Long Time. Even if you qualify for federal loan forgiveness, it can take a long time for your loans to be eliminated. ...
- Forgiveness Isn't Guaranteed. ...
- Your Debt Could Increase While You Wait. ...
- You Could Lose Out On Higher Salaries. ...
- You Might Be Taxed.
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.
Why should we be against student loan forgiveness? ›
Even modest student loan forgiveness proposals are staggeringly expensive and use federal spending that could advance other goals. The sums involved in loan-forgiveness proposals under discussion would exceed cumulative spending on many of the nation's major antipoverty programs over the last several decades.
Why shouldn't student debt be forgiven? ›
Consider that 65 percent of the country has not attended college and, therefore, has no student loans. Biden's call to forgive debt for college graduates illuminates an elitist disregard for other kinds of debt—often incurred without a choice. It's classist, uncharitable, elitist, and unfair toward most Americans.
What would happen if student loans are forgiven? ›
If you qualify for forgiveness, cancellation, or discharge of the full amount of your loan, you won't have to make any more payments on that loan. If you qualify for forgiveness, cancellation, or discharge of a part of your loan, you'll need to pay back the remaining balance.
Who is most affected by student loans? ›
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.
In this article:
| Pros and Cons of Student Loans | |
|---|
| Pros | Cons |
|---|
| Accessible to college students with no or limited credit histories | Default can lead to very serious consequences |
| Lower interest rates than other financing options | They may not be enough to cover all of your expenses |
1 more rowSep 28, 2022
Another study, published in April 2023 in the journal Addictive Behaviors, followed 331 college graduates and linked high debt levels with problematic drinking, anxiety and depression, especially among the most economically insecure graduates. In some cases, borrowers even expressed suicidal thoughts.
Will student loan forgiveness increase taxes for everyone? ›
Student loan forgiveness in 2022 will not increase your federal taxable income, thanks to the latest American Rescue Plan that makes all student loan forgiveness tax-free.
Why is student debt a problem? ›
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 student loans affect income? ›
Fortunately, student loans aren't taxable, so you don't report student loans as income on your tax return, and you don't have to pay taxes on certain types of financial aid.
Will forgiving student loans increase taxes? ›
President Biden's student debt relief plan does not raise taxes to pay for it, which is something only Congress can do.
Why is student loan forgiveness not fair? ›
Myth: Student loan forgiveness is the fair way to help Americans escape massive amounts of debt. Fact: Borrowers signed on the dotted line for their loans. Erasing these loans does not teach borrowers to manage their debts. Moreover, the cancelation is an insult to those who diligently paid off their loans.
Why is the student loan forgiveness not a good thing? ›
The rapid inflation in the cost of college is, in large part, due to rampant government subsidies in higher education. Forgiving student loans only makes that problem worse. The Success Sequence is a formula that outlines areas we can work in that will reduce poverty.
Will student loan forgiveness increase GDP? ›
Broad student debt cancellation can stimulate the macroeconomy and boost GDP. Freeing up funds through debt cancellation would allow millions of borrowers to spend into the broader economy.
