Student loan forgiveness: What’s next?

August 25, 2022
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The Biden administration recently announced plans for forgiving a portion of student loans for millions of Americans. Specifically, borrowers who hold loans with the Department of Education and make less than $125,000 a year ($250,000 for married couples) are eligible for up to $20,000 in student loan forgiveness if they obtained Pell Grants, while individuals who make less than $125,000 a year ($250,000 for married couples) but did not receive Pell Grants are eligible for $10,000 in loan forgiveness. 

The Department of Education will announce details on how borrowers can claim this relief in the coming weeks, with the application expected to be available no later than when the pause on repayments terminates at the end of December. Millions of borrowers will be able to receive relief automatically based on existing income data.

If you have student loan debt, you may be counted among those millions who qualify for forgiveness. But then what? We’ve put together some “next steps” info, as well as some tips for using this financial relief to your best advantage.

What happens now?

You may have questions about how to move forward, or what will happen. Unfortunately, the answers aren’t one-size-fits-all, but here’s some basic information.

Your balance will change. Depending on how your communications are set, you’ll receive notification of your loan discharge via email, snail mail, and/or your online loan servicing account. You should also see a zero or diminished balance on the Federal Student Aid site — a zero balance if your entire loan is forgiven, or a reduced balance if only a portion of your debt is canceled. If that’s the case, you’ll still owe monthly payments. If you receive a specific type of discharge (such as a closed school loan discharge), you could receive a refund of some or all payments you made on the loan.

Your credit report may also change. You’ll want to keep an eye on your credit report during this time (visit annualcreditreport.com), especially if you had delinquencies or defaults associated with your loan(s). Depending on the type of forgiveness or discharge, defaults or delinquencies could be wiped clean, and you could regain eligibility for federal student aid.

However, if your loans were in good standing and are now paid off, whether through making a final payment or through debt cancellation, you could see a minor ding to your credit score. That may not seem to make sense, as one would think a loan payoff should be good for credit, but student loans are considered installment loans (similar to auto loans or home loans) and your credit score is highest when you have a mix of credit types. When you eliminate an account (like a student loan), it signals you no longer have an installment loan account in the mix. Not to worry: The score decrease is temporary, and having a debt paid off shows you’re a reliable borrower. Plus, it can improve your overall financial picture by reducing your debt-to-income ratio.

Tax implications should be considered. If your student loans are forgiven, you’ll receive a cancellation of debt form, known as Form 1099-C, to use when filing taxes. This will indicate whether the amount forgiven is considered taxable.

Most recent loan forgiveness has not been taxed. This includes public service loan forgiveness, borrower defense to repayment discharge, closed school discharge, and total and permanent disability discharge.

Debt forgiven through income-driven repayment forgiveness (which is automatic after 20 or 25 years of repayment) is usually considered taxable income. However, the March 2021 American Rescue Plan deemed all forgiveness will be tax-free through the end of 2025. All income-driven repayment forgiveness after Dec. 31, 2025, will be taxed if the plan is not extended. If this happens, you’ll report any canceled debt as income on your tax return after consulting your preferred tax professional.

What should you do with the extra money?

Having your student loan debt forgiven — or even reduced — is a welcome change to the budget, and it may have you itching to splurge. But before you move forward, you’ll want to think through some smart strategies for using your monthly debt dollars (the money you usually put toward student loans). If you still have a student loan balance, the answer’s pretty obvious. If not, it may be time to address financial strategies you have been forced to delay.

You could cover more of your basics. This is an excellent time to take a look at your monthly budget and assess how well you’re meeting your essential needs. Do you consistently fall short in one or more areas — particularly those that are increasing (gas, groceries, property taxes, etc.)? Then those areas could probably use the extra cash before any other category gets bolstered. Take a second look at the things your kiddos need, also. Once you have reviewed household supplies, food, utilities, and related necessary expenses, you can move on to the next category.

You could budget for larger expenses. Another great reallocation target is those larger expenses that come up once or twice a year that can really leave a mark on your budget if you’ve forgotten (or couldn’t afford) to plan for them. We’re talking holiday expenses, insurance, family entertainment, even school supplies. With some proactive budgeting, these expenditures won’t sting quite so much, and now that you have a little more money each month, planning for them will be easier.

You could build your emergency savings. When folks talk about emergency savings, there are really two types: short-term and long-term. Your short-term emergency fund (which is a great place to start saving) should contain $500–$1,000. A great guideline is an amount that’s equal to your highest insurance deductible. It can be used for orthodontia, a broken bone, etc.

As a general rule of thumb, long-term emergency savings should ideally equal three to six months of living expenses. This would cover your family for a few months in the case of a temporary layoff, unemployment, or a large-scale event that affects the economy for an extended period of time, as the pandemic did.

You can revisit your financial goals. What’s been standing in the way of reaching your financial goals? Now you may be able to address any high-interest revolving debt, or it might be the right time to pay down your mortgage. Need wheels for your teen, or college tuition for kids of any age? Extra funds are the perfect opportunity to pad the 529 or whatever college savings vehicle you’re using.

You may not be ready to retire now, but you’re no doubt preparing for it. While you’re reviewing your budget, check what you’re contributing to your employer’s retirement plan. If they offer a match, you’ll want to make certain you’re taking advantage of the full amount; this is a great time to increase your contribution. If you haven’t started contributing yet, it looks like you’ve found a great use for your extra funds, and if your employer does not offer such a program, a conversation with your banker or a financial advisor can get you started prepping for retirement on your own.

We’ve given you some ideas for your extra monthly coffers; now all that’s left is to take pencil to paper (figuratively speaking — there are some great apps for that, like our own UBTgo app) to see where applying your funds makes the most sense. Need some personalized assistance with an account? Stop in to your nearest UBT location or contact us online, and we’d be happy to help!

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