Federal student loan forgiveness is kind of like the Tooth Fairy as a child. You know that somehow you can end up with more cash, but figuring out how it works and when you’ll actually get the money can be elusive.
Unlike the Tooth Fairy, federal student loan forgiveness is very real. While the benefits have been waiting for those lucky enough to have their loans forgiven, the time for most federal student loan forgiveness is approaching fast.
What is federal student loan forgiveness?
Federal student loan forgiveness is a way for some student loan borrowers to have a portion of their loans forgiven (private loans are not eligible for forgiveness).
There are several different types of forgiveness programs, each designed to benefit different types of borrowers.
Public Service Loan Forgiveness
The Public Service Loan Forgiveness program allows those working in public-service careers to have the remainder of their loans forgiven after 10 years.
To qualify, borrowers must have a strong on-time payment history, hold a qualifying public service job for 10 years, and be on an income-based repayment plan. After making their 120th payment, the remaining student loan balance is forgiven.
Teacher Loan Forgiveness
For teachers, there is an even better possible deal. The Teacher Loan Forgiveness program kicks in at 5 years rather than 10 years. Different types of teachers receive varying amounts of loan forgiveness, but up to $17,500 may be forgiven after 5 years of teaching.
Forgiveness for income-driven payment plans
Income-driven repayment plans are built for those with the worst student loan debt burdens relative to their income.
Borrowers who are eligible may receive student loan forgiveness on their remaining balance after 20 years (240 payments) through the Pay as You Earn (PAYE) program.
Learn more and compare income-driven repayment plans here.
Perkins loan forgiveness
Perkins loan borrowers have another list of criteria for federal student loan forgiveness. If you are a firefighter, police officer, librarian, or work in another qualifying occupation, you may be eligible for loan forgiveness after 10 years of eligible payments.
When will loans be forgiven?
The first loans with a 120-month forgiveness window entered the Public Service Loan Forgiveness program in October 2007. That means the first loans will be forgiven in October 2017.
Business Insider examined federal public service employee student loan data for borrowers in this program and found that in the first year, $1 to $2 billion in federal student loans will be forgiven.
That same data set shows that the total annual forgiveness rate is expected to rise to around $5 to $7 billion per year by 2025 as more borrowers reach the 10-year mark on their student loans.
Forgiveness under the PAYE plan applies to borrowers as of 2007, and REPAYE as of 2015. That means PAYE borrowers will start to see relief in 2027, and REPAYE borrowers in 2035. Income-based repayment (IBR) began in 2009, but is also retroactive for some older loans.
If you have completed your 5 years of service under the Teacher Loan Forgiveness program, you can fill out an application for forgiveness here.
Beware the student loan forgiveness tax
It’s not all rainbows and unicorns for borrowers seeing their student loans forgiven in the future. There is a big tax consequence that borrowers must understand. Knowing what is coming can help prepare for a big tax bill.
Here are the basics on how federal student loan forgiveness plans impact your taxes. (Note that Public Service Loan Forgiveness and Teacher Loan Forgiveness programs are tax exempt, and the following does not apply in those scenarios.)
Forgiven student loans are treated the same as regular income on your tax return. Your lender will send you a tax form at the end of the year telling how much was forgiven, and that number is added to your paycheck and other income from the year to calculate your income.
Many of you will fall in the 25% tax bracket, so let’s use that as an example. If you are like the average borrower in the dataset above from Business Insider, you’ll have $8,000 forgiven. That means an extra $2,000 owed on your tax return come tax day!
If you have bigger loan balances thanks to private school tuition, out-of-state tuition, or dreaded medical school tuition, however, you could have a lot more forgiven.
If, for example, you have $100,000 forgiven through the PAYE program, that could translate to a $25,000 tax bill! You read that right. For $25,000, you might need a whole new personal loan to afford your taxes!
If you expect your student loans to be forgiven in the future, you should start a new savings fund just for the taxes. Do the math and figure out what amount you expect to be forgiven, then round up to be safe.
Calculate the number of months you have left until your forgiveness day. Divide your total forgiveness amount by the number of months to figure out how much you need to save per month to pay off your loans.
Plan, prepare, and get out of debt
With any student loan changes or strategies, always take the time to plan, understand the details, and prepare for your next step.
Whether that is consolidation, refinancing, or student loan forgiveness, always go into it with the best knowledge and preparation to avoid costly mistakes and surprises. If you do, you’ll be out of debt in no time.
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