How Does Student Loan Forgiveness Affect Your Finances?

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 advisor who 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 to investigate 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.