The idea of having your student loan debt forgiven might sound like a dream come true, but there are a few things you’ll want to consider should you be among those eligible for student loan forgiveness.
It turns out that there are many ways to get federal student loans forgiven. In fact, the Consumer Financial Protection Bureau a few years ago estimated that more than a quarter of working Americans are eligible for the Public Service Loan Forgiveness Program, but only a small percentage are actually using it.
And while student loan forgiveness in and of itself may not negatively impact your credit, the status of your loans before and after you enter into a forgiveness program could, so it’s important to thoroughly discuss with your lender how your loan discharge will be reported.
“Before entering into a loan forgiveness program, be sure you understand how the loan will be reported on your credit report,” said Rod Griffin, director of Public Education at credit bureau Experian. “For there to be no negative impact on your credit scores, the loan must be reported as if it were paid according to the original contract terms.”
That means you might need to negotiate if you’ve made any late payments or gone into default.
Let’s say you qualify for forgiveness because of a disability, and you fell behind on your student loans due to medical bills, inability to work and other factors that might impact your finances. If, when your loan is discharged, the servicer reports the missed payments to the credit bureaus, your balance will show up as zero, but those late payments will remain on your credit report.
You can try to persuade the lender (or collector if it’s gone that far) to remove the blemish from your reports, and they might consider it if you have a good explanation as to why it happened.
Also, if the lender indicates that the account was settled for less than originally agreed, that could also hurt your credit scores, Griffin said.
“It should indicate it is paid in full and that there are no delinquencies in the credit history” in order to not negatively affect your credit, he said.
Errors in your payment history also can negatively impact your credit score, so it’s a good idea to check your credit reports before entering into a student loan forgiveness plan. By doing so, you’ll be able to dispute any errors on your student loan accounts and have them corrected. You can start that process by checking your free credit scores, updated monthly on Credit.com, which will also show you major credit scoring factors like payment history. You can also get a free copy of your credit reports from each of the major credit bureaus annually.
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Will You Pay Taxes?
Certain types of student loans that are forgiven are not taxable, but other types are, so it’s good to know where you stand so you aren’t shocked by a big tax bill. A good place to begin your research is our primer on taxes after student loan cancellation. While President Obama’s 2017 budget proposal seeks to exclude Department of Education loan forgiveness programs from taxable income, it will require Congressional action to make that happen.
If you’re already behind on payments, there are some options available to help you get back on track, even if forgiveness isn’t one of them. To get out of default, you can combine eligible loans with a federal Direct Consolidation Loan, or you can go through the government’s default rehabilitation program. If you make nine consecutive on-time payments (these can be extremely low), your account goes back into good standing, and the default is removed from your credit report.
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