Can Student Loans Lower Your Credit Score?

Student loans are much like other loans. Your credit rating gets a boost when you make your payments on time. Likewise, when you fail to make payments on time, your loan could fall into a delinquent status, which also causes your credit rating to suffer.

94817320While the government allows you a certain period of time (for most, it’s six months) to begin paying off student loans once you leave college, not all students are able to begin making payments. However, instead of communicating with their lenders, they often simply ignore the debt, which has a horrible effect on credit scores. To avoid negative credit impacts, lenders offer many options to students who are struggling to make their payments, including deferment or forbearance. These options keep loans in good standing, while allowing you to buy a bit more time to get into a better financial situation.

Student loans are viewed as “good credit” and when they’re in good standing, can help you qualify for other forms of credit later on. However, your credit score can take a dive if you pay off your loans too soon. This is because you benefit from having more than one type of credit. Your student loan is an installment loan, and once it’s paid off, while you’ll save money by not paying all of that extra interest to your lender, you will be potentially removing one type of credit from your credit report.

Many student loan borrowers worry that they’ve ruined their credit because they have defaulted on their loans. The good news is that it’s never too late to make things right. Options are always available to help you repay those loans and repair your FICO score. It might take some time, but if you’re dedicated to resolving the issues, you’ll get there, perhaps even sooner than you think.

Ask a Tax Preparer: Will I Have to Pay Taxes on Forgiven Debt?

Via LearnVest By Laura Shin ~

Over on our discussion board, an interesting question arose concerning two popular subjects: student loans and taxes.

See, there’s a group of people out there who know that student loan debts can be forgiven. This may be news to most of you, who’ve probably heard that student loans can never be forgiven even in cases of bankruptcy. And although that’s mostly true, for a small group of select borrowers (we outline who they are below), they can be forgiven.

This led folks on our discussion board to pose the following query: Would they be taxed on the amount of debt that was forgiven?

After all, if $30,000 of their loans is forgiven, then the taxes on that could be sizable. Whether or not forgiven debt is taxed also applies to people in other situations, such as those who’ve had the value of their mortgage written down by a lender.

To find out the answer, we spoke with Chris Arotin, an enrolled agent with the I.R.S. But before we address the exact question, it’s important to note that people who file for bankruptcy (i.e. for credit card debt, not student loans) don’t have to pay taxes on the forgiven amount and this is unlikely to change. So, if you’re in that boat, you can breathe a sigh of relief. Now, onto the answer …

Mortgage Forgiveness

We’ll tackle the mortgage situation first because it’s a bit easier. Let’s say that you purchased a home for $450,000, and post housing crisis, it’s now only worth $250,000. The bank does some restructuring, and you only owe the $250,000 that it’s worth. What would normally happen is that the I.R.S. would then treat it as if you had $200,000 extra dollars in earned income and it would tax you on that amount.

forgiven debt

But for the years 2007 to 2012, there was a law in effect called the Mortgage Forgiveness Debt Relief Act. “According to this debt relief act, the amount that the bank forgave doesn’t count for tax purposes,” says Arotin. Well, up to a limit. For a single person or for a married person filing separately, the I.R.S. will not tax up to $1 million of forgiven debt, and for a married couple filing jointly, it won’t tax up to $2 million of forgiven debt.

This also applies to other situations in which your debt is written down, such as a short sale. (This is when you, say, buy a house for $450,000, sell it for $250,000 before paying off your debt and the lender forgives the remainder.)

While this law was still in effect for the 2012 tax year, starting in 2013, the I.R.S. will not be refraining from taxing this type of forgiven debt, so if you get the value of your mortgage written down this year, be prepared for a hefty tax bill.

Forgiven Student Loans

Situations in which student loans can be forgiven are rare. The most common way is through the Public Service Loan Forgiveness Program, which will forgive debt that remains after 120 payments for people who are employed full-time by certain public service employers.

“Most of these loans are structured in a way where the borrower has to work a certain amount of time in the given field,” says Arotin. “So be proactive and inquire about forgiveness while you’re going through the student loan process by asking if the program qualifies for one of the provisions.”

In order for your forgiven loan amount to not be taxed, the loan must have been made by:

  1. The federal, state or local government. If, say, the University of Tulsa gave you a loan, this doesn’t apply to you.
  2. A tax-exempt public benefit corporation that has control of a state, county or municipal hospital whose employees are considered public employees.
  3. A school that administered loans from the institutions described above or that has a program encouraging students to work in underserved occupations. Most of these loans are structured in a way that requires the student to work for a certain amount of time in that field, so borrowers will likely find out their requirements”i.e. how long they have to work in that field before the loan will be forgiven when taking out the loan.

One caveat: While many people think that their loans are federal loans, the law distinguishes between loan money that actually came from the government versus from a private lender. Only government loans are eligible for forgiveness.

For more information, check out the student loans section of I.R.S. Publication 4681, which describes tax treatment of canceled debts and foreclosures.