What is 'Student Loan Forgiveness'
Student debt has reached an all-time high in the U.S. of late, with an estimated 40 million people now owing an average balance of $29,000, according to credit report company Experian. With student loans soaring, debt-saddled students and graduates are desperate for any strategy that may help them escape their burden. Under certain circumstances, federally backed student loans – such as Direct Subsidized Loans and Federal Perkins Loans – can be discharged or forgiven.
The prospect of your student debt evaporating may seem like a dream come true. In reality, though, not that many people end up being eligible. Requirements vary depending on the type of loan, but most offer forgiveness for those employed in certain public-service occupations. Let's look at various options for dealing with student debt: discharge, forgiveness, repayment, debt consolidation – and finally, the worst that can happen if you simply don’t pay.
When Student Debt Can Be Discharged
For a federal education loan to be discharged, there must be circumstances beyond the borrower’s control that prohibit repayment. Most loans can be discharged in the following situations:
- Permanent disability of the borrower
- Closure of the school during the time of study
- Falsification of the loan qualifications by the school
- Use of identity theft to secure the loan
- Failure of the school to refund required loans to the lender
- Death of the borrower
"Circumstances beyond the borrower's control" do not include things like having to drop out of college before graduation or inability to find a job after graduation. However, there is a possibility that they could include a school using illegal recruiting tactics – for example, guaranteeing the student a well-paid career.
According to The Wall Street Journal, more than 7,500 borrowers (with collective debt of $164 million) have applied for debt relief under a 1994 regulation including violation of applicable state law via an act or omission of the school as a defense against repayment. In June 2015, the U.S. Department of Education promised debt relief to students of the bankrupt for-profit Corinthian Colleges schools (click here for more information on how to apply). The Department has already agreed to cancel nearly $28 million of Corinthian students' debt, the Journal reported.
Forgiving Student Loans
Student loan forgiveness can be earned in two ways: by working in public service or by making payments through income-contingent payment plans for a (long) period of time. Each has its own conditions, requirements and limitations. Neither route is quick or easy.
The Public Service Loan Forgiveness Program (PSLF) is designed specifically for people who work in public service jobs, either for the government or for a nonprofit organization. You may also be able to get all or part of your loan forgiven through certain types of volunteer work, military service or medical practice.
In order to get some debt forgiven under the public service program, you must first make 120 qualifying payments (meaning, paying the minimum amount due on time). These payments must be made while you are working for a qualified employer – generally, a federal, state or local government organization or a nonprofit organization with tax-exempt status: In effect, you qualify after 10 years on the job and 10 years of payments. Potentially-eligible positions include those in nursing, government, police, fire and social work. Only payments made after October 1, 2007, qualify towards earning eligibility, so borrowers won't reach the 120-payment milestone to qualify for forgiveness until 2017.
If you aren’t working in a public service position, you may still be able to get some of your student debt forgiven – but it will take longer. Federal income-based repayment plans allow for some debt forgiveness after a minimum of 20 years (terms and conditions vary by program).
Only direct loans made by the federal government (the William D. Ford Federal Direct Loan Program) are eligible for student loan forgiveness. Non-federal loans (those handled by private lenders and loan companies) aren’t part of this program. If you do not have a William D. Ford Direct Loan, and instead borrowed through the Federal Family Education Loan Program (FFEL) or Perkins Loan Program, you are allowed to consolidate these debts into a Direct Consolidation Loan; this new piece of consolidated debt would then be eligible for public service loan forgiveness, under the same terms as those described above. Keep in mind that only payments made on the combined loan count toward the 120-payment minimum; earlier payments made on the old loans don't get considered.
As with anything related to the federal government, the terms related to student loan forgiveness are subject to change. Regardless of any alterations that may be on the horizon, Mark Kantrowitz, senior vice president and publisher of Edvisors.com and author of "Filing the FAFSA," warns borrowers against betting their financial future on the hope of debt forgiveness, especially the kind that's tied to public service. For one thing, there's a rigid time limit: “Public service loan forgiveness occurs after 10 years of full-time service. It is an all-or-nothing benefit, so borrowers who stop working before reaching the 10-year mark will get no forgiveness.”
What Service Qualifies for Student Loan Forgiveness?
Your eligibility for student loan forgiveness not only depends on the type of student loan but the type of service.
According to the Federal Student Aid website, PSLF-qualifying jobs consist of “any employment with a federal, state, or local government agency, entity, or organization or a not-for-profit organization that has been designated as tax-exempt by the Internal Revenue Service (IRS) under Section 501(c)(3) of the Internal Revenue Code (IRC)."
Here are some further particulars about the sort of work that qualifies:
By volunteering through AmeriCorps VISTA, AmeriCorps NCCC or AmeriCorps State and National programs, you can receive up to $5,775 toward repaying qualified student loans (loans backed by the federal government) through the Segal AmeriCorps Education Award.
Another option for student forgiveness is the Army National Guard's Student Loan Repayment Program, which can help you earn up to $50,000 toward loans. Covered loans include Federal Direct Loans, Perkins Loans and Stafford Loans.
By volunteering with the Peace Corps, 15% of your Perkins Loan balance will be forgiven for each year of service.
As a full-time elementary or secondary school teacher in a low-income community, you can have 15% of your Perkins Loan forgiven for years one and two of employment, 20% in years three and four, and the remaining 30% in year five. Federal Direct Subsidized and Unsubsidized Loans – and Subsidized and Unsubsidized Federal Stafford Loans – may also be forgiven if you teach an understaffed subject such as math, science, or special education or work in a school in a low-income neighborhood. Click here for the latest details on these programs.
For medical and nursing school graduates, working in underserved areas can qualify you for student loan forgiveness under state programs.
Income-driven repayment plans, designed to help graduates who are having trouble making payments within the standard 10-year time frame, also include forgiveness for borrowers not in the public sector after a certain period of time. While it takes decades for forgiveness to happen, borrowers have rushed to get on board. According to figures released by the Department of Education in August 2015, nearly 3.9 million Americans were enrolled in an income-based or income-contingent repayment plan, a 56% increase since June 2014, to deal with a collective total of more than $108 billion in outstanding debt. The plans have a two-pronged appeal: the possibility of lower monthly payments now, plus the chance for balances to be forgiven later.
These plans include:
- Income-Based Repayment (IBR): Maximum monthly payments will be 15% of discretionary income. Forgiveness eligibility after 25 years of qualifying payments.
- Income-Contingent Repayment: Payments are recalculated each year based on gross income, family size and outstanding federal loan balance. Forgiveness eligibility after 25 years of qualifying payments.
- Pay As You Earn (PAYE) and Revised Pay As You Earn (REPAYE): Maximum monthly payments will be 10% of discretionary income. Forgiveness eligibility after 20 years of qualifying payments. The government may even contribute part of the interest on the loan.
- If you work for a federal agency, your employer may repay up to $10,000 of your loans per year, with a maximum of $60,000, through the Federal Student Loan Repayment Program.
Your student loan servicer handles the repayment for your federal student loans, so work with the servicer to enroll in a repayment plan or change your current plan. You can usually do this online via the company’s website. To apply for the public service forgiveness program, both you and your employer need to complete and file a specified form.
Forgiveness and Repayment Plans: The Cons
Income-based repayment can also have a downside: More interest will accrue on your loan, because the repayment is stretched over a longer period of time. “Loan payments under IBR and PAYER can be negatively amortized, digging the borrower into a deeper hole,” Kantrowitz notes. “Borrowers who expect to have a significant increase in their income a few years into repayment should perhaps prefer a repayment plan like extended repayment or graduated repayment, where the monthly payment will be at least as much the new interest that accrues and the loan balance will not increase.”
"Remember, payments change annually based on income. When your income rises, your payment can, too,” notes Reyna Gobel, author of CliffsNotes Graduation Debt: How to Manage Student Loans and Live Your Life. Even if you succeed in lowering monthly payments, don't go on a spending spree with the newly available funds, she adds. “If you're currently racking up more debt because you expect these plans in the future: stop! You never know what will or won't exist for graduates if the law changes in the future. Ask yourself, 'Could I afford to repay this on a regular extended repayment plan?' If not, you could be getting yourself into very high debt and a difficult situation."
All is not perfect with forgiveness plans, either. The sort of service jobs that offer student loan forgiveness often come with lower pay than than regular, private-sector positions. You might be able to repay your loans more quickly through a job with greater earning potential, even if it doesn't offer loan forgiveness.
If you do have all or part of your student loans forgiven, be aware that the IRS may consider the forgiven debt as income and you may have to pay tax on that amount. Also, if you choose to participate in any loan-forgiveness program, make sure to obtain written verification before you begin of what amount will be forgiven and under what circumstances.
Student Loan Consolidation
If you have more than one student loan, you may have heard about or considered consolidating your loans. Consolidating student loans is a process where you take out a new loan, which is then used to pay off your other existing student loans. You can consolidate all federal student loans and most private student loans.
In most cases you are considered eligible to consolidate your loans if you are:
- not currently in school or are enrolled at less than part-time status
- currently making loan payments or are within the loan's grace period
- have a good repayment history (meaning you are not in default on your loans)
- carrying at least $5,000-$7,500 in loans
While you do not need to meet any minimum for combining debt under the federal Direct Consolidation Loan program, private lenders and loan companies tend to demand a minimum loan balance. You cannot consolidate private student loans with federal student loans, and you can only consolidate the loans you hold in your name; this means that you cannot consolidate your own loans with your spouse's or with loans your parents may have taken out to finance your college education.
Advantages of Consolidating
The pros of consolidating your student loans include:
1. Streamlining your bill payment process. With just one loan, you have only one repayment due date to remember and one check to write.
2. Extending your repayment term. With a new loan, you can lengthen the amount of time you have to repay, often between 12 and 30 years (up from the standard 10).
3. Lowering your interest rate. If you have one or more private student loans and have improved your credit score since obtaining your loan, you may be able to qualify for a consolidated loan with a lower interest rate.
4. Switching from a variable to fixed-rate loan. If you have private student loans at differing variable rates of interest, you may be able to consolidate and get one new loan with a fixed rate of interest – a good move if rates have dropped significantly since you were in school.
5. Lowering the monthly payment amount. Lengthening the term of your loan means that you will be paying less each month.
6. Getting into an alternate repayment plan. Consolidation offers a way to select a different payment schedule, such as:
- Graduated repayment, which allows you to begin payments at a lower monthly amount and then gradually increases that repayment amount every two years.
- Income-sensitive repayment, which calculates your monthly payment amount as a percentage of your pretax monthly income.
7. Getting borrower benefits. Lenders will often offer loan holders certain benefits (discounts for auto-payments, a record of on-time payments, etc.) for being a good borrower. If your lender does not provide any benefits, you may want to consider consolidating your loans with a lender who does.
Potential Disadvantages of Consolidating
The cons to consolidating your student loans include:
- paying more in total interest
- having a larger total loan repayment amount
- being in debt longer (if you extend your loan period)
- losing borrower benefits from your current lender (i.e. interest-rate discounts, rebates)
- having to repay borrower benefits (i.e. rebates, fee waivers)
- possible prepayment penalties
- loss of grace period (if you consolidate loans during their initial grace period)
Beware of Fraud
Unfortunately, there are plenty unscrupulous lenders offering to consolidate student loans. You should be wary if a lender promises to dramatically lower your interest rate by consolidating your federal student loans. The truth is that lenders weight the average of the interest rates you're currently paying on your existing federal student loans and then round that number up to the nearest one-eighth of a percentage. While the interest rate on the new loan may be lower than the higher interest rate, it will also be higher than the lower interest rate you're currently paying. So overall you'll be paying about the same or perhaps just slightly more for your new, consolidated loan. Let's look at an example.
|Marisa is paying 3.6% on a $3,500 Stafford loan and 6.8% on a $6,500 Stafford loan. If she were to consolidate those loans, a legitimate lender would calculate her new interest rate using the following formula:
($3,500 x 3.6%) + ($6,500 x 6.8%) / ($3,500 + $6,500) = 5.68%. This would be rounded up to 5.75%.
While the overall interest rate on the consolidated loan is less than the 6.8% Marisa was paying on the $6,500 loan, it's significantly more than the 3.6% she was paying on the $3,500 loan.
You should also be skeptical if a lender charges you an upfront fee (or fees) that you need to pay out-of-pocket to consolidate federal loans. Fees and/or expenses associated with federal loans should be deducted from the new loan check, not charged to the borrower.
Lastly, be cautious if a lender states that you have to choose a repayment plan with a different term limit to consolidate. If you have a Perkins, Stafford or PLUS loan you can always choose to stick with the 10-year repayment plan for your consolidated loan.
Before you consolidate your student loans, you should crunch numbers: Consider how much longer you will need to repay the loan and how much more in total interest you will have to pay as a result, and weigh that against the benefit of a lower interest rate and smaller monthly payments.
What Happens if You Don't Pay?
If you fail to pay your student loan, you probably won't find a team of armed U.S. marshals at your front door, as one Texas man did recently. But it’s still a very bad idea to ignore that debt.
In most respects, defaulting on a student loan has exactly the same consequences as failing to pay off a credit card. But in one key respect it can be much worse. Most student loans are guaranteed by the federal government, and the Feds have got powers that debt collectors can only dream about. It probably won’t be as bad as armed marshals at your door, but it could get very unpleasant.
Here’s what happens.
First You’re ‘Delinquent’
That means that any new applications for credit may be denied, or given only at the higher interest rates available to risky borrowers. A bad credit rating can follow you in other ways. Potential employers often check the credit ratings of applicants, and use it as a measure of your character. So do cell phone service providers, who may deny you the service contract you want. Utility companies may demand a security deposit from customers they don’t consider credit worthy. A prospective landlord might reject your application, too.
Next You’re ‘In Default’
When your payment is 270 days late, it is officially “in default.” The financial institution you owe the money to refers the problem to a collection agency. The agency will do its best to make you pay up, short of actions that are prohibited by the Fair Debt Collection Practices Act. Debt collectors also may tack on fees to cover the cost of collecting the money.
It may be years down the road before the federal government gets involved, but when it does, its powers are considerable. It can seize any tax refund you may receive, and apply it to your outstanding debt. It can also garnish your paycheck, meaning it will contact your employer and arrange for a portion of your salary to be sent directly to go towards repayment.
What You Can Do
A good first step is to contact your lender as soon as you realize that you may have trouble keeping up your payments. It may be able to work with you on a more doable repayment plan, or steer you toward one of the federal programs. It is important to remember that none of the programs are available to people whose student loans have gone into default.
You may be sure the banks and the government are as anxious to get the money as you are about repaying it. Just make sure you alert them as soon as you see potential trouble ahead. Ignoring the problem will only make it worse.