At first glance, the decision is easy: student loan forgiveness on an IDR plan is obviously better than repaying the debt in full, even if forgiveness takes 20 years.
Upon closer reflection, things are not so obvious. Twenty years of living with debt is a long time. Between taxes and interest payments, forgiveness might not be the best deal. A short sprint may be better than a long marathon.
Typically, when we discuss chasing student loan forgiveness versus repayment in full, it is in the context of public service loan forgiveness. Today, the discussion will focus on aggressive repayment and compare it to 20 or 25-year forgiveness from Income-Driven Repayment (IDR). We will also cover what borrowers stuck in the middle should do.
Student Loan Forgiveness Isn’t Free Money
Repaying some debt may sound preferable to repaying all of the debt, but it isn’t that simple.
The federal government has many IDR repayment plans. These plans include Income-Contingent Repayment (ICR), Income-Based Repayment (IBR), Pay As You Earn (PAYE), and Revised Pay As You Earn (REPAYE). Forgiveness takes 20 or 25 years, depending upon the plan selected.
Another thing the IDR plans have in common is that they suffer from many of the same drawbacks for borrowers who wait for forgiveness instead of choosing to repay their loans.
Several factors can make chasing forgiveness expensive:
Federal Taxes – Student loan forgiveness can come with a huge tax bill. As a general rule, the IRS treats forgiven debt as income. Thus, if you have $50,000 of student debt forgiven, you may be taxed as though you earned an extra 50k that particular year. Some borrowers call this the student loan forgiveness tax bomb.
There have been calls for Congress to change this rule for student loans, and PSLF forgiveness is already tax-free. However, under the current law, IDR forgiveness borrowers need to prepare for a large tax bill.
Student Loan Interest – Letting a student loan linger for two decades means the loan has time to generate a lot of interest. In some cases, borrowers may spend much more chasing forgiveness than they would if they just repaid their loan. The Department of Education Student Loan Simulator is an excellent tool for evaluating the cost of forgiveness.
Attacking debt means the balance quickly shrinks. A shrinking balance means less interest generated each month. The cost of interest can tip the scales so that forgiveness is the more expensive strategy.
Making Too Much Money – File this in the category of good problems to have. Monthly payments on an income-driven repayment plan go up as you earn more money. At a certain point, you may make enough money that your monthly payments pay off the debt before reaching forgiveness. The borrowers who fall into this category would have been better off with aggressive repayment.
How Does Aggressive Repayment Work?
The idea behind aggressive repayment is that the sooner you repay your debt, the less you spend on interest.
Some people take it to the extreme and move back in with their parents, eat as cheaply as possible, and put every penny they have towards their debt.
While this approach can be effective, it clearly isn’t for everyone.
For most borrowers, aggressive repayment usually means paying extra each month or refinancing the debt at a lower interest rate. The big danger with refinancing is that it converts the federal debt into a private loan. This means federal perks like student loan forgiveness and income-driven repayment are gone forever.
However, refinancing may save a fortune in interest. At present, the following lenders are offering the best refinance rates:
| Rank | Lender | Lowest Rate | Sherpa Review |
|---|---|---|---|
| T-1 |  | 5.28% | ELFI Review |
| T-1 |  | 5.28%* | Splash Financial Review |
| 3 |  | 5.49% | Laurel Road Review |
Due to the high stakes of the situation, borrowers must exercise care when making a decision.
Deciding Between IDR Forgiveness and Repaying Student Debt in Full
The cost of making a mistake may be high, but for many borrowers, the decision is surprisingly easy.
Sometimes the math will be clear. After running the Loan Simulator for your loans, you may see that even if your salary doubled, you will still have plenty of debt to forgive at the end. This makes chasing forgiveness a better choice. Alternatively, you may realize that there will be hardly anything to forgive after 20 or 25 years. In this case, repayment in full is likely the path to saving the most money.
Finally, there are circumstances where chasing forgiveness is the only reasonable choice:
- I will never be able to pay off my debt. If your student loan balance is so large that you have no meaningful chance of paying it back, chase forgiveness. There may be a large tax bill, and it may take decades, but you still have a viable path to debt freedom.
- I have concerns about job security. If a sluggish economy or negative performance review might leave you unemployed, forgiveness is probably the better option. The IDR plans were designed to protect borrowers who are unemployed or underemployed for extended periods of time.
Many other borrowers may not have an obvious decision.
Delaying the Decision on Chasing Forgiveness for 20-25 Years vs. Debt Elimination
When the best option isn’t apparent, a middle ground approach may be best.
The middle ground approach leaves the door open on forgiveness but prepares for repayment in full.
Borrowers should do the following:
- Enroll in an Income-Driven Repayment plan and make payments as though they were chasing forgiveness.
- Delay refinancing any federal loans. A private refinance eliminates the possibility of forgiveness.
- Set aside some money each month for future payments. Building up a large emergency fund is an option.
- Revisit the forgiveness vs. repayment decision at least once a year.
After a year in the middle ground, the right decision may be apparent. If you were able to set aside a ton of money for future payments, you might be ready for aggressive repayment. The money set aside can be used to start the attack.
If you were not able to save anything extra, attacking the debt might not be possible. Borrowers that decide to chase forgiveness can keep the money set aside to prepare for the tax bill that comes with student loan forgiveness.
