Can your student loan debt be forgiven?

By Robert DiGiacomo

If you feel trapped under a mountain of student loan debt or worry about interest rates rising in the future, a loan forgiveness program may ease some of your burden.

Federal programs exist that will forgive the remainder of your federal student loan debt if you work in the public sector or for a registered nonprofit for 10 years and keep current with your payments. Others allow you to stretch out your loan payments if your income falls below a certain level and will forgive the remainder of your debt after 25 years.

Which loans are eligible for forgiveness?

Federal student loans that qualify for relief include Stafford loans, Federal Direct PLUS loans and Direct Consolidation loans, according to Mark Kantrowitz, publisher of FinAid.org, a financial aid information site.

Perkins loans are also supposed to have a foregiveness provision for borrowers who become certain types of teachers, but Congress has not funded this provision for several years, according to Kantrowitz. Thus anyone seeking forgiveness for a Perkins loan would have to convert it into a Direct Consolidation loan before applying.

No matter the loan or program, money borrowed by parents usually cannot be forgiven, Kantrowitz says.

Forgiveness for public service

The Public Service Loan Forgiveness program is open to students who have Federal Direct loans who become police officers, firefighters, EMT workers or public school teachers, as well as those who take other qualifying positions in the public and non-profit sectors.

"The program is a back-end loan forgiveness program," Kantrowitz says. "You work for a certain number of years and any remaining debt is forgiven."

The program requires participants to work in public service for 10 years and make 120 on-time loan payments, after which any remaining undergraduate and graduate debt will be forgiven. The program can identify whether your job makes you eligible when you begin working.

"You don't have to wait 10 years to find out if your job qualifies," Kantrowitz says. "There's a form you can have your employer complete that will say whether your service qualifies."

Stafford Loan options

The Stafford program fields its own set of loan forgiveness options. Provisions exist for those who volunteer with AmeriCorps, the Peace Corps or Volunteers in Service to America, serve in the Military National Guard, teach at the primary or secondary level in schools with low-income students, specialize in teaching math or science at the secondary level or teach special education.

Stafford forgiveness is also available to law school students who work for public interest or non-profit organizations, and medical students who practice as physicians for a certain time in communities that do not have "adequate medical care," according to the Stafford loan website.

The requirements and eligible amounts for Stafford loan forgiveness vary, depending on your volunteer or teaching service. Also, you're not eligible for Stafford relief if you already participate in the Public Service Loan Forgiveness program.

Income-based loan relief

The Income-Based Repayment plan allows you to repay your Stafford, Direct and Consolidation Loans based on how you much earn, as long as your loans are not in default. Parent PLUS loans are not eligible for the program.

The yearly amount you pay will equal 15 percent of the difference between your adjusted gross income and 150 percent of the Department of Health and Human Services poverty guideline for your family size and state. The total is then split among 12 monthly payments.

Slowing down the payment of the loan will mean that you accrue more interest than if you paid off the loan under the regular terms, according to Kantrowitz. But if you participate in the plan for 25 years and meet certain requirements, the remainder of your loan will be forgiven.

Tax implications of loan forgiveness

The Public Service Loan Forgiveness program has no tax consequences -- the amount of your loan that is absorbed by the government is not considered taxable income, says Kantrowitz.

However, under the Income-Based Repayment plan, the forgiven portion of your loan is taxable. So if the government has forgiven $100,000 of your debt, you will have to pay federal tax on that amount as if it were income. In that scenario, someone in the 25 percent tax bracket could owe $25,000 in taxes, Kantrowitz says.

"The federal government is making payments to itself or lenders," Kantrowitz says. "The total amount the government is paying to cancel debt is treated as income to you."

Since the income-based plan just launched in 2009, the 25-year mark is still decades away. According to Kantrowitz, it's possible that the government will have to address the issue once these bills come due.

"What most likely is going to happen is, 25 years from now, there will be people faced with huge tax bills," Kantrowitz says. "There will be a hue and cry and Congress will pass something."

Still, borrowers who consider this option should note these potential tax consequences before applying.