With millions and millions of Americans carrying federal student loan debt, the mere thought of loan forgiveness might sound too good to be true.
To be honest, for most graduates, it probably is. This means that, based on the current loan forgiveness programs available, qualifying for loan forgiveness is probably a pipe dream for most borrowers.
If you’re one of the lucky ones that do qualify for a loan forgiveness program and you are considering it, you will want to read through these nine hidden risks to ensure you are well versed on the ins and outs of loan forgiveness.
What’s Ahead:
1. Your credit might take a hit
Debt forgiveness in itself will not automatically lead to a hit on your credit score. Instead, it is the method in which your debt is forgiven that matters. For instance, if your debt is forgiven through a student loan forgiveness program, your credit will not be directly affected. However, if your loan is “forgiven” using a settlement or bankruptcy, then your credit score may suffer for years to come.
If you don’t qualify for a student loan forgiveness program and you are looking for ways to manage your payments, a better approach might be to consolidate your loans.
2. You might be taxed on the forgiven amount
Another risk of loan forgiveness to be aware of is related to your favorite subject…taxes! Depending on the type of loan that is being forgiven, you may be taxed on the amount of forgiven debt. As an example, let’s say you have $10,000 of loans forgiven. That forgiven debt is then to be reported as additional income on your taxes, meaning that you will be taxed on it!
There are exceptions. For instance, if you receive student loan forgiveness under the PSLF program, you won’t be taxed. However, if you are eligible for loan forgiveness and are considering it, be sure to prepare yourself in advance for tax time. I recommend opening a savings account as soon as you decide to pursue debt forgiveness where you can make monthly deposits to cover the extra financial burden.
3. You (or your loan) might not be eligible for forgiveness
Depending on the type of student loan you have, you might not even be eligible for loan forgiveness. If you are carrying private student loans, you are not eligible for any of the federal student loan forgiveness programs, so you will want to keep that in mind before wasting your time with most loan forgiveness applications.
While your options are more limited if your student loans are through a private lender, there is still hope for payment assistance. Specifically, the student loan repayment assistance program (LRAP). Through this program, the amount of assistance you receive is directly related to your income.
If you are interested in applying for a government loan forgiveness program be sure to read the fine print. Know exactly what is needed to qualify and then determine if you are ready and willing to adhere to these rules for 5, 10, or 25 years. In some cases, it might not be worth it.
4. Loan forgiveness can take a long time
Loan forgiveness often requires a long-term commitment. So, if you have commitment issues, you might want to come up with another plan. When it comes to the government student loan forgiveness programs, you are looking at a 5-year commitment with the Teacher Loan Forgiveness program, 10 years with PSLF, and between 20 and 25 years with the IDR program.
In 5, 10, or 25 years, you might be able to come up with a better repayment plan than those that are offered through the federal debt forgiveness programs. Again, it’s your choice but this is good food for thought.
5. You might not have a balance to be forgiven
Since many of the loan forgiveness programs take years of repayment before you are even eligible, chances are you might have your loan paid off before you can even use the forgiveness program. This is especially true if you find yourself moving up the career ladder and making more and more money.
Paying off your loan is not a bad thing. The sooner you get it paid off, the sooner you can forget about it and redirect those funds elsewhere. However, this is something you will want to think about when you are deciding early on if you want to commit to a loan forgiveness program.
6. You may end up paying more
If you’re enrolled in an IDR program (more on this below) and you decide to extend your repayment terms to make your monthly payments more affordable, you will end up paying more money in interest than you would without enrolling in the program. While your monthly payments will be lower and more manageable, your debt will last longer and, as a result, you will spend more of your hard-earned cash.
If you can manage higher monthly payments, it might make more sense to pay off the debt faster and avoid the additional interest. Obviously, this isn’t always an option but keep this in mind if you are on the fence about extending your repayment period.
7. You might be limiting your job prospects
To qualify for certain student loan forgiveness, you must work in one of the fields that are eligible for PSLF. A qualifying employer for PSLF is a government organization or not-for-profit organization that is tax-exempt under Section 501(c)(3) of the Internal Revenue Code.
Maybe this won’t be an issue for you. However, if you have dreams of being a small business owner, an entrepreneur, or even working in the private sector, you will have to decide what is more important – following your dreams or maintaining your eligibility for loan forgiveness.
8. You may be limiting your salary potential, too
As was just mentioned, the types of jobs that qualify for PSLF programs are in government and not-for-profit positions. These positions typically pay less than private-sector jobs. While it might seem like the best financial decision to stay in a government position long-term to ensure you are eligible for loan forgiveness, you have to ask yourself, at what cost?
You might be missing out on higher-paying positions that would allow you to pay off your student loans faster and move on to bigger and better things. Again, it’s a difficult decision that you will have to balance. Just be aware that loan forgiveness is not guaranteed and it’s not always the best option.
9. You might feel trapped in a job you hate
Let’s say you go to college to become a teacher. You graduate with a considerable amount of debt and want to apply for student loan forgiveness. To be eligible for Teacher Loan Forgiveness, you need to put in five consecutive years of service. What if after your first year two you realize that a career in teaching is not for you? What do you do?
Do you move on or stick it out to try and ensure that you will be eligible for debt forgiveness? It’s a tough question but one you will have to weigh if you find yourself in this position.
What is loan forgiveness?
Loan forgiveness occurs when you are released from your obligation to pay back part of your loan. To achieve this, there are usually specific eligibility criteria you need to meet and commit to (i.e. the type of job you have, how much you’ve already paid back, etc.)
Let’s take a more in-depth look at some of the loan forgiveness programs currently available:
- Public Service Loan Forgiveness. If you are employed by the government or work at a not-for-profit organization, then you may qualify for the public service loan forgiveness (PSLF) program. The PSLF program provides student loan forgiveness on your Direct Loan. With this program, the balance of your Direct Loan will be forgiven once you have made 120 qualifying loan payments (which will take approximately 10 years). During this time you must also be working for a qualified employer.
- Teacher Loan Forgiveness. If you have been employed as a full-time teacher for five consecutive years in a low-income elementary school, secondary school, or educational service agency, you might be eligible for the Teacher Loan Forgiveness program. The teacher loan forgiveness program provides forgiveness up to $17,500 on Direct Loans or Federal Family Education Loans (FFEL).
- Income-Driven Repayment Program. This program is meant as a way of making loan repayments more affordable. The income-driven repayment (IDR) program helps to reduce monthly payments based on your income. Depending on the type of IDR program, the remainder of your loan balance may be forgiven after 20 to 25 years of payments.
- Loan Repayment Assistance Programs. The loan repayment assistance program (LRAPs), now called Ardeo Education Solutions, collaborates with colleges and universities to help students with student loan debt. To be eligible for LRAP, graduates must meet certain work and income criteria.
Summary
Loan forgiveness has the potential to be a helpful and financially solid option for some. However, it’s important that you are aware of the hidden risks associated with loan forgiveness. In order to qualify for many programs, you have to strictly adhere to eligibility requirements and you have to be prepared to commit.
There is no one right answer when it comes to whether or not you should pursue loan forgiveness. It is really a matter of balancing the pros and the cons. What are you willing to give up in the pursuit of forgiveness and is it worth it? Will you have your loans paid off before you can even qualify and are you giving up a dream career or the potential to go after a higher paying gig because you are so focused on obtaining forgiveness?
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