Can your thousands of dollars of student loan debt go poof—and magically disappear, just like that?
That’s the dangerous implication of so-called student loan “forgiveness” programs, which, considering all the terms and fine print, may turn out too good to be true.
While these programs may indeed benefit certain individuals, bear in mind that there are strict eligibility criteria, not only at application, but throughout your loan term. And, no one ever mentions the big tax that might be waiting for you at the end.
It’s important to be aware of the caveats—and there are many. Here are the facts.
Forget the Pros, Let’s Skip to the Cons
Before you sign up for anything, understand what you’re getting yourself into.
But first, if you need to understand more about the different types of student loan forgiveness programs and who they may benefit, check out this in-depth article.
Get Ready for a Big Tax Bill
The biggest issue facing anyone enrolled in an income-driven repayment program with a loan forgiveness feature is the potential tax bill on the forgiven loan balance amounts.
Only the balances under Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness (TLF) programs are exempt from taxes.
Under current Internal Revenue Service (IRS) rules, any forgiven loans are considered taxable income. Which means the entire balance of your forgiven loan amount will count as income, and you’ll be taxed for it.
If you have higher student loan debt, then this will most certainly apply to you.
If you have lesser student loan debt, then you may very well pay off your total debt before the end of your loan term, before any forgiveness kicks in.
Keep in mind that any deferrals and hardship periods count toward the overall debt repayment term, but, your balances will still increase if you do not make any interest payments during this time—and let’s face it, most people don’t.
Here’s an example: Let’s say that after making payments under IBR for 25 years, you’re left with $40,000 in debt. That $40,000 in forgiven debt would be considered taxable income.
Though you’ll no longer pay $40,000 in student loans, you’ll have a hefty tax bill to pay based on $40,000 of income, or possibly a mean $10,000+ federal tax bill, which doesn’t include potential state income taxes.
This makes sense if you are in a lower tax bracket later in retirement and you have saved enough over 20 to 25 years to pay off the bill, but given that you were in an income-driven plan all along, do you really think you’ll be ready to pay it in full?
What income, savings, home equity, or other resources would you have to access in order to satisfy your tax payment? If you can’t pay it, you’ll have to sacrifice your tax refunds and/or make the payment over the course of several payment installments.
Is participating in such loan forgiveness programs, then, even worth the hassle? Perhaps only if you’re a public servant or teacher.
Qualifying (and Re-Certifying) Is a Hassle
Keep in mind, with all income-driven repayment plans, you must recertify your income and family size each year. This means your monthly payments will increase or decrease according to your status.
Until your student loan amount is forgiven, you have to adhere to a list of requirements to ensure you can remain in the program.
Depending on your program type, you may have to satisfy meeting certain income caps, obtaining steady employment, and not falling behind on loan payments.
Consider this carefully. You are, in essence, committing that you won’t make over a certain amount of money, ever. Who knows what the future holds? You should never limit income-generating potential. You should also never commit to being gainfully employed all the time (what happens if you want to take time off to travel or start a new business?). Finally, no one’s perfect, and you can’t guarantee that all payments will be made on time, every time.
So what to do if you don’t want to enroll in such programs? Many private lenders and new student loan platforms offer the chance to refinance your student loan debt. You may wish to consider these options if you don’t meet IBR eligibility requirements, but you’re still interested in consolidating or re-negotiating your loans for a lower rate or payment, or shorter loan term.
Still Interested in IBR? Here’s How to Get Started
While student loan repayment and forgiveness do offer some benefits to qualifying borrowers, such as lower monthly payment options and the chance to get rid of student loan debt in less time and for less cost, it’s absolutely crucial to review the facts.
Don’t say we didn’t warn you.
You must review all available plan information, specific criteria, loan terms, and payback instructions. Only after you’ve done all your research and understand the program’s impact on your present and future finances, should you then consider moving forward with an application, and preparing your paperwork and documents.
To learn more about the Public Service Loan Forgiveness Program, click here.
To learn more about the Teacher Loan Forgiveness Program, click here.
If you are interested in learning more about what loan repayment plans are available, click here.