What is the “Catch” with Student Loan Forgiveness?

Michael Lux Student Loan Blog, Student Loan Forgiveness 0 Comments

There is a lot of fine print with student loan forgiveness. To say there is a “catch” with student loan forgiveness might be an understatement. In fact, there are several reasons student loan forgiveness might not be as good as it seems.

That said, for many borrowers, student loan forgiveness still represents the best path to debt freedom.

Once you understand how student loan forgiveness works, the reality of the situation is clear. It is not too good to be true. Instead, student loan forgiveness is a challenging path that is potentially very rewarding for borrowers.

High Rejection Rates: Student Loan Forgiveness Isn’t Easy

Many borrowers mistakenly assume that after ten years of work in public service or 20 years of repayment, their loans will disappear.

The harsh reality is that many borrowers have their applications for forgiveness rejected. When the first batch of borrowers became eligible to apply for Public Service Loan Forgiveness, the rejection rate was over 99%. The real rejection rate isn’t that high, but approval is far from a certainty.

Likewise, forgiveness after 20 years of income-driven repayment is far from automatic. The National Consumer Law Center estimates that over two million borrowers have been in repayment long enough to qualify for IDR forgiveness, yet only 32 have qualified. Here again, the numbers should improve for borrowers, but assuming that you will qualify is a mistake.

The lesson with these high rejection rates is that attention to detail is critical.

Don’t Rely on Student Loan Servicer Assurances

One of the biggest obstacles for borrowers chasing forgiveness has been lousy advice from student loan servicers.

Bad information from some servicers was the subject of a Consumer Financial Protection Bureau lawsuit. I’ve personally spoken with many borrowers who were told they were on their way to forgiveness, only to learn that they were not.

Making this problem even more severe is the fact that there isn’t a remedy for most borrowers. If you rely on bad information from your servicer, you are often out of luck. Congress has tried to address this particular issue with the Temporary Expanded Public Service Loan Forgiveness program. Sadly, it only helps some PSLF borrowers who were on the wrong repayment plan.

If there is good news in this situation, it is that this issue is starting to improve. Servicers now get better training on loan forgiveness issues, and borrowers do a better job researching the rules. However, there is still plenty of room for improvement.

Borrowers can still ask their servicers for help and guidance, but they need to verify the information provided.

The Student Loan Tax Bomb

Even if you do everything right and your loans get forgiven, the “catch” is that you may have a huge tax bill from the IRS.

The IRS usually treats forgiven debt as income the year it is dismissed. There are a couple of exceptions to the basic rule for student loan forgiveness. First, Public Service Loan Forgiveness is never taxed. Second, the other forms of federal student loan forgiveness are not taxed if the forgiveness occurs before December 31st, 2025.

Borrowers that do not qualify for either expectation may have to pay a large tax bill. In the student loan community, that tax bill has come to be known as the student loan tax bomb.

Thoughts from the Sherpa:
I’m optimistic that Congress will eventually remove the student loan tax bomb. However, as an IDR borrower, I’m not counting on Congress delivering. I have a plan in place to handle the tax bomb.

Federal Student Loan Cancellation from President Biden or Congress

Some borrowers are already planning on having the federal government cancel their student loans.

These borrowers are making the mistake of counting their chickens before they hatch.

While there is certainly reason for optimism about federal cancellation, it is a long way from becoming a reality. At present, one political party is 100% opposed to loan cancellation, and the other party only has some members interested. There are many legal and political hurdles in the way of student loan cancellation.

The “catch” with this form of student loan forgiveness is that it may never happen for anyone.

Still Interested in Loan Forgiveness?

The big lesson here is that student loan forgiveness is far from a certainty. However, it isn’t impossible either.

Borrowers interested in loan forgiveness should do the following:

Subscribe
Notify of
guest
0 Comments
Inline Feedbacks
View all comments