Student Loan Forgiveness

By Jonathan G. Cameron, CFP. ®

As of early 2015, the amount of outstanding student loan debt in the U.S. was up to $1.2 trillion. This is a staggering number! Tens of millions of young professionals in the United States are carrying significant student debt balances. Not only will it take years to pay off many these loans, but these large balances often result in a delay in other types of spending by those under age 40. The purchase of a first home or serious retirement savings is too often pushed back to later years. Maybe this describes you. Are there federal programs available that provide student loan forgiveness? Answer: Yes … but there is a catch. There are a couple of programs that fall under income-based repayment that I will discuss here.

Only certain kinds of federal student loans qualify for forgiveness under income-based repayment, such as Stafford and Grad PLUS loans. Each year, program participants must verify income and family size, all of which factors into the monthly amount required to apply towards student debt.  Since this program is income-based, the intent is to assist borrowers whose income is low compared to their outstanding loans.

The 10-Year Income-Based Repayment Plan

The federal government will forgive your student loans in 10 years if you are a government employee pursuing a career in public service or work at certain non-profits. The rules for this program are rigid, but as long as you work in a qualifying job over 10 years, and make on-time monthly payments during this period, the remaining loan balance will be forgiven at the end of the term. This isn’t for everyone. Borrowers need to understand program requirements and be OK with working for 10 years with only specific kinds of qualified employers. As of 2008, the discharge of remaining student loan debt after the 10 years are up is tax-free.

The 25-Year Income-Based Repayment Plan

Most student borrowers will not work in the public or non-profit spheres, so are there income-based loan forgiveness options available for those who work in private industry? Yes, but as with the 10-year program, there are specific rules and criteria that need to be followed in order to qualify for a loan discharge. If a college graduate’s income remains low, on time payments are made each month, and the loans still aren’t paid off after 25 years, the remaining loan balance is discharged. However, unlike with the 10-Year plan for public sector employees, the balance forgiven is taxable to the borrower in the year of discharge. This is called “phantom income” since you don’t actually receive income, but the loan amount forgiven is taxable.  This could potentially run a taxpayer up into higher brackets, thereby greatly increasing tax burden for that one year.  The borrower needs to be sure that he isn’t simply exchanging one debt (student loan balance) for another (income taxes due).  As with the previous plan, this isn’t for everyone. The rules are strict and in order to qualify for forgiveness a borrower needs to abide by them.

An important point to keep in mind is that loan forgiveness will not happen in any situation without years of monthly payments. What will be forgiven is the remaining balance. With the 25-Year option in particular, the borrower needs to determine whether paying down the loan on his or her own can be done in less time than 25 years.

One further point:  those who have consolidated loans to a private loan servicer will not qualify for either income-based payment plan. Parent PLUS Loans are not eligible either.

So when determining whether pursuing loan forgiveness under the income-based repayment plans is appropriate, borrowers need to know what they’re getting into. And know that there is always a catch…

A final note:  If your parents have co-signed any student loans for you, do a good thing:  get a cheap term life insurance policy on yourself, with them as beneficiaries. As co-signers, they would be on the hook for this debt if you pass away. You don’t want them stuck with your remaining loan balance if something happens to you.



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