Although millions of students take out student loans to fund their undergraduate and graduate studies, the burden of repaying student loans after graduation can feel like a huge shock for many borrowers. Luckily, federal loan forgiveness programs exist for those who qualify. But how will your personal finances be impacted by enrolling in these programs? Let’s take a closer look.
How Student Loans Could Affect Your Credit Report
Your credit report tracks how much you borrow and how timely you are when repaying your loans, and a credit score (in many cases known as a FICO score) is like a grade on your credit report. Lenders use this information to assess your credit risk. A good FICO score reflects responsible borrowing, while a negative one can hinder your financial goals, potentially making it hard to secure a loan or credit card with favorable terms.
Student loans, like any other loan, can impact your credit report and FICO score depending on your payment habits. Timely payments and responsible credit behavior will have a positive effect and could lead to better borrowing opportunities.
Does Student Loan Forgiveness Impact Your Credit Score?
As long as your student loans are in good standing at the time they’re canceled, loan forgiveness will likely have minimal impact on your credit score. In fact, it may even rise.
But it gets a little tricky if you’ve missed loan payments. Once the loan is forgiven, your balance will be marked as paid on your credit report. Unfortunately, any history of late or missed payments may still remain on the report for seven years. Lenders are not obligated to remove it. It is this negative history that can lower your credit score, not the loan forgiveness itself. However, any inaccurately reported payment activity can be disputed with the credit bureaus.
Is the Forgiven Amount Taxable?
Tax rules vary depending on the forgiveness program and where you live—always consult a financial advisor to ensure you understand any implications. Here are a few examples that may apply:
Generally, if you’ve satisfied the requirements for Public Service Loan Forgiveness (PSLF), your federal student loan will be forgiven tax free–except in certain states, where you may have to pay state taxes.
If you’re eligible for Income-Driven Repayment (IDR) forgiveness, any canceled loan amount can be considered taxable income by the IRS on both federal and state levels. This could be hefty if your student loan is especially large. Thanks to the American Rescue Plan, however, anyone who receives federal student loan forgiveness between 2021 and 2025 will not have to pay federal taxes.
The Importance of Understanding the Fine Print
There are times when we all skim the fine print—but student loan forgiveness programs shouldn’t be among them. Each one comes with its own set of rules and conditions, often with complex criteria.
The PSLF program, for instance, requires you to work for a specific type of employer and make at least 120 qualifying payments over ten years before you are eligible for forgiveness. An IDR plan calibrates your monthly payment amount based on your gross income and family size, and requires timely payments over 10, 20, or 25 years, depending on which plan you’re enrolled in and how much you owe.
Repayment, application, or recertification missteps can cause you to lose eligibility or force you to extend your repayment plan. So, understand the requirements, be aware of what you’re getting into, and seek assistance when you need it.
Consult the Experts and Do Your Research
Navigating student loan forgiveness is a difficult journey, and it’s wise to seek guidance from financial and tax professionals. They can provide personalized advice based on your unique circumstances, allowing you to make well-informed decisions. Understanding program details and potential consequences will empower you to manage your finances wisely.
Disclaimer: This content does not necessarily represent the views of IWB.