Public Service Loan Forgiveness gets all of the headlines, but most Americans are employed by a private sector, for-profit employer. Do these employees have access to student loan forgiveness programs? How do they qualify?
All federal student loan borrowers are eligible for student loan forgiveness, including private sector and for-profit employees. There is no cap on the amount of debt that can be forgiven, but it takes at least 20 years to reach forgiveness under the current law. Private student loans are not eligible for loan forgiveness.
Even though forgiveness for private sector employees can take a very long time, it can result in significant savings. The ideal strategy will depend upon an individual’s borrower’s income and total student loan balance.
Qualifying for Student Loan Forgiveness as a Private Sector Employee
By using an Income-Driven Repayment (IDR) plan, employees of for-profit companies can get their student loans forgiven.
Though there are many different income-driven repayment plans for federal student loans, the basic rules are the same. Borrowers are expected to make payments based upon what they can afford, rather than what they owe. As the chart below shows, borrowers are expected to pay 10, 15, 0r 20% of their discretionary income towards their student loans each month. After 20 or 25 years worth of payments, the remaining student loan balance is forgiven.
|Plan||Discretionary Income Required||Years Until Forgiveness|
|ICR - Income-Contingent Repayment||20%||25|
|IBR - Income-Based Repayment||15%||25|
|PAYE - Pay As You Earn||10%||20|
|IBR for New Borrowers*||10%||20|
|REPAYE - Revised Pay As You Earn||10%||20 or 25**|
** Borrowers with graduate school debt will take 25 years, while those with undergrad only can qualify after 20 years.
Dealing with federal student loans for over 20 years is a very long time. This type of forgiveness is far from a quick-fix, but it does provide a light at the end of the tunnel for borrowers living on a smaller income and dealing with larger amounts of federal student debt.
Outside of the long wait for forgiveness, the other major downside is that the forgiven debt can result in a huge tax bill from the IRS…
Planning for a Large Tax Bill
As a general rule, the IRS treats forgiven debt as income. If a student loan borrower earns $30,000 during the year and has $20,000 of student loans forgiven, that taxpayer will pay taxes as though they earned $50,000 that year.
In other words, a student loan problem can easily turn into an IRS problem.
The tax on the forgiven debt is often referred to as the tax-bomb by borrowers planning on IDR forgiveness.
It is worth noting, however, that there is growing support for eliminating the taxation of all forms of student loan forgiveness. Public Service Loan Forgiveness does not come with a tax bill, and a recently created law eliminated the tax bill for student loans forgiven due to the death of the borrower.
Those that are pursuing IDR student loan forgiveness should plan for extra taxes the year the debt is forgiven. If student loan advocates can eliminate the tax bill, borrowers that set money aside will be able to use the funds towards retirement or other financial goals.
Dealing with Private Student Loans
Unlike federal student loans, private student loans do not have options for forgiveness.
Private student loan rules are set by the contract that borrowers sign with lenders. These contracts have strict repayment terms that can make things difficult for borrowers on a tight budget.
In most cases, the best option for dealing with private loans is to refinance the loans at a lower interest rate when possible. The problem with this approach is that the refinance lenders are unlikely to help borrowers who are struggling with their debt. Most refinance lenders target borrowers who are less of a credit risk. Fortunately, competition between lenders has become fierce, and the number of borrowers who are successfully able to refinance has grown. Some can qualify for rates just over two percent.
The limited options for private student loans should be a major consideration for borrowers developing a plan for their loans…
Putting Together a Strategy for Debt Elimination
Because federal student loans are more flexible and eligible for forgiveness, most borrowers opt to pay off their riskier private student loans first. These borrowers typically start repayment by aggressively paying off their private loans while enrolling their federal student loans in an income-driven repayment plan.
Any borrower that thinks loan forgiveness might be a possibility should get enrolled in an IDR plan as soon as possible. Borrowers can always pay more than the minimum payment, but the low monthly payments that IDR plans can offer allow for maximum flexibility.
The big question that many borrowers will face is whether or not it is worth it to go after student loan forgiveness. Have the debt eliminated via forgiveness sounds like an ideal option, but it can cost more in the long run.
Chasing forgiveness can be expensive because borrowers the low monthly payments can mean significant interest accumulation. Paying a loan off in ten years will cost significantly less in total compared to paying off the same loan in 20 years. The large tax bill when the loan is forgiven can tip the scales in favor of paying the debt off in full.
One useful tool for evaluating repayment options is to use the federal student loan repayment estimator. This Department of Education resource allows borrowers to estimate how much they will pay each month on the various repayment plans. It also provides borrowers with an estimate of how much could be forgiven at the end of repayment.
In some cases, it will be obvious that chasing after forgiveness will be more expensive than just paying the debt off in full. In other cases, it will be obvious that forgiveness is the best bet. Borrowers who are caught in the middle should enroll in an income-driven repayment plan while they consider their options. These borrowers can make the minimum payments required for forgiveness and set any additional income aside in a savings account. This middle-ground approach will get the forgiveness clock started, but leave open the possibility of aggressive repayment.
Focusing on the Important Detail
Student loan forgiveness sounds very appealing in theory, but in reality, it may not always be the best approach.
Borrowers working in the private sector should know that forgiveness is an option, but they shouldn’t assume that it is the best way to eliminate student debt.
Rather than focusing on how much is spent each month, all student loan borrowers should carefully consider the total cost over the life of the loan. From this big-picture point of view, it is much easier to evaluate the usefulness of student loan forgiveness.