If you’re going through the process of having your student loans forgiven, you’re probably ready to break out the bubbly and celebrate. But before you do, it’s a good idea to understand the full extent of the ways student loan forgiveness can affect your credit score, and also to be prepared for any expenses you might owe as a result of the forgiveness. We’ll cover all that and more here.
Federal student loan forgiveness programs
There are quite a few student loan forgiveness programs available depending on what you studied and the field you work in. Most of these are considered to be taxable income by the Internal Revenue Service (IRS). To find out which ones are taxable and other information on eligibility, consult the tables below.
Tax-exempt loan forgiveness programs
|Public Service Loan Forgiveness (PSLF)||Must be a full-time employee in a qualifying public service position||120 loan payments|
|Teacher Loan Forgiveness||Your loans originated after Oct. 1, 1998, your loans are not in default, and you have worked full-time in a qualifying school for at least five consecutive years||5 years of service|
|NURSE Corps Loan Repayment Program||Must be a registered nurse, nurse practitioner, or nurse faculty member serving a high-needs population||2 years of service|
|National Health Service Corps (NHSC) loan repayment assistance||Must be a licensed primary care doctor, nurse practitioner, dentist, or mental/ behavioral clinician||2 years of service at an eligible site|
Taxable loan forgiveness programs
|Forgiveness with Income-Based Repayment (IBR)||Qualifying income||20 to 25 years of payments|
|Forgiveness with Pay As You Earn (PAYE)||Qualifying income||20 years of payments|
|Forgiveness with Revised Pay As You Earn (REPAYE)||Anyone with qualifying federal student loans||20 to 25 years of payments|
|Forgiveness with Income-Contingent Repayment (ICR)||Anyone with qualifying federal student loans||25 years of on-time payments|
|Federal Perkins loan cancellation||A federal Perkins loan and employment in a qualifying profession||Forgives a certain percentage of debt after every year of service|
|Indian Health Services (IHS) Loan Repayment Program*||Must be a doctor committed to practicing in an American Indian or Alaska Native community for a minimum of two years||N/A|
|National Institutes of Health (NIH) Loan Repayment Programs||Must be health professional committed to two years in a research position at a qualifying nonprofit||N/A|
|Loan forgiveness for doctors in the Armed Forces||Varying criteria depending on the branch of military in which service is provided||N/A|
|Department of Justice Attorney Student Loan Repayment Program (ASLRP)||Must be a lawyer who worked for a minimum of three years at the Department of Justice, with at least $10,000 in federal student loans||N/A|
|Military student loan forgiveness and assistance||Varying criteria depending on the branch of military in which service is provided||N/A|
Note: The Indian Health Services (IHS) Loan Repayment Program is partially taxable — with the program paying 20% of your federal tax liabilities. The recipient would be responsible for any remaining federal, state or local taxes.
Beyond these nationally recognized programs, you may also be eligible for programs that are specific to your state and occupation, which you may also need to consult about their tax implications. For example, the John R. Justice Student Loan Repayment Program and the Herbert S. Garten Loan Repayment Assistance Program, two programs for lawyers working in the public sector or for a qualifying public service organization, both advise anyone pursuing forgiveness through them to seek advice independently through a tax professional or the IRS.
Does student loan forgiveness affect your credit?
Student loan forgiveness does affect your credit — but probably not in the way you’re thinking. Like most transactions involving debt, student loan forgiveness can affect your credit in the same way that having the loans in the first place can. The important thing to remember, is that as long as you continue to make payments on time until the loans are forgiven, the loan forgiveness will not negatively affect your credit score.
Some people might worry that getting rid of loans will hurt their credit score. Although having a long (and positive) repayment history can help your credit score, getting rid of the loans won’t damage it. And while this positive history is a good thing, you’re better off taking the loan forgiveness when you qualify. Because although it won’t hurt your score to continue paying your loans on time, it may block you from taking out other loans (like a mortgage) in the future, depending on your debt-to-income ratio.
Another point to remember is that any late payments on your loans have the potential to stay on your credit history even after the loans have been forgiven. This happens because your lender isn’t required to remove the negative history once it’s been reported to the credit bureau — which would happen at the time of the late payment. Since payment history makes up 35% of your FICO score, missing even one of those payments can make your score drop significantly. According to the National Foundation for Credit Counseling, one missed payment could even lower your score by as much as 100 points.
Depending on the type of forgiveness you qualify for, you may find the loan and any payments you made completely wiped from your credit history. Although it outwardly appears to be the same as loan forgiveness, this is actually called student loan discharge — the process by which borrowers get their loans completely cancelled. It’s important to note that these situations are pretty rare, with only seven events qualifying a borrower for a loan discharge.
Planning ahead for student loan forgiveness
Student loan forgiveness can be a huge financial relief, but if you’ve qualified as a result of years spent on an income-driven repayment plan — don’t start celebrating just yet. Under these types of plans, the IRS considers the forgiven amount to be taxable income, and you’ll be expected to pay those taxes in full the year your loans are forgiven. In fact, the majority of loan forgiveness programs are considered taxable income, with only a small minority of them (notably those serving the public in fields like health, education or law) being exempt.
To give you some idea of what a resulting tax bill might look like, let’s assume you have $30,000 worth of loans forgiven and earn $30,000 per year. If you’re filing as single, instead of being taxed on your $30,000 income, you’d now be taxed on $60,000 worth of income. In 2018, this would have bumped you into a higher tax bracket as well, making your effective tax rate 22% instead of what you’d otherwise have owed at 12% — and you’d receive a tax bill for a whopping $9,140 (instead of $3,410).
To get ahead of this potentially crippling expense, start saving early. Set up regularly scheduled deposits from your checking to your savings account, and save for the max amount you may owe. For extra clarity and peace of mind, you might consider working with a tax professional who can help you calculate more precisely what the bill will look like — that way, you won’t be in for any nasty surprises.
What to do after your loans are forgiven
After your loans are forgiven and you’re squared up with the IRS, it’s time to start thinking about what to do with the income that’s no longer tied up in student debt. A few options you may consider include: paying off other debts, building an emergency fund, and saving for retirement. You could tackle all three at once or one or two of them, if you choose.
High-interest debt can eat away your monthly cash flow. Credit cards are a good example of high-interest debt. There are two main strategies for getting your credit card debt under control:
- Debt avalanche: This repayment strategy has you focus on paying off your highest-rate balance first. Once it’s repaid, you’ll roll your payments over into the debt with the next-highest rate.
- Debt snowball: A snowball works similarly to an avalanche. You’ll work on paying off your smallest debt balance first, and work your way up to higher balances over time.
Both strategies work well, so long as you continue to make minimum payments on your other cards to avoid damaging your credit score. It’s a matter of personal preference as far as which method makes you feel like you’re getting your debts under control, and you’ll want to choose which one works best for you.
Building an emergency savings fund is important when dealing with an unexpected expense or financial emergency, such as if you lose your job or get into a car accident. Your fund should could cover three to six months’ or more of expenses. This type of fund could help you avoid taking on debt in case your financial situation goes south.
A retirement plan is important, as well. A recent study from Stanford advises that Americans save anywhere between 10% to 17% of their annual income (starting at age 25) in order to be on track to retire at 65. If you haven’t started by then, the required savings only increases. In order to avoid being one of those people spending more on take-out than retirement, familiarize yourself with what you need to save and make a plan to use your extra income wisely.