Student loan payments guide to what to know about interest, loan servicers and taxes now that ‘pause’ is over
People had a lot of questions about interest, student loan servicers and whether a canceled student loan counts as taxable income. Here are some answers.
Elise Amendola / AP
An estimated 43 million federal student loan borrowers have to start making payments this month for the first time in three years. More than 1.5 million Illinois residents cumulatively have a total of $61 million in student debt.
We asked people to share their hopes, fears and questions in the lead-up to the end of this pandemic-era payment pause.
“The interest rates on my student loans are super-duper high and it always feels as if I am putting out a fire with my tears only,” wrote one borrower, Marco Colapietro, a high school counselor from Elk Grove Village.
In an effort to dispel confusion and anxiety, here are answers to some of the questions we heard about interest, student loan servicers and whether a canceled student loan counts as taxable income (answer: It depends).
INTEREST
Why does the federal government charge student borrowers interest?
To recover the costs of lending money.
“If the government lent money without charging interest, that would represent a cost because … they can’t spend it until it gets repaid,” said Sam Brunson, a tax scholar at Loyola University Chicago’s School of Law.
For instance, because of inflation, $1,000 lent to a student five years ago and repaid today would be worth less than its original value. If the government didn’t charge interest, it would have to cover that cost some other way.
“That might mean increasing the taxes, that might mean cutting other programs,” said Mark Kantrowitz, who writes about college financial aid and scholarships. “Congress doesn’t want to do that, so it’s much easier for them to charge interest on it.”
Elizabeth Tandy Shermer, a history professor at Loyola, put it another way.
“Your interest payments are replenishing for the next generation of students who need the money,” said Tandy Shermer, who wrote the book “Indentured Students: How Government-Guaranteed Loans Left Generations Drowning in College Debt.”
Tandy Shermer said Congress came close to passing a broad undergraduate grant program in the 1950s, but the idea of giving money to students without charging them was considered un-American.
“The United States was unique in terms of getting high school to be universal and also to have public schooling,” she said. “And we’ve really fallen down on higher education. It’s this habit and custom that you are supposed to, at some point, pay for your college degree.”
Was interest charged on federal student loans during the pause? Will I have to pay it?
No. According to the U.S. Department of Education, the pause on repayments that began in March 2020 and ended Sept. 1 also placed a pause on interest. That means your loan balance should not have accumulated interest during the last three years. Nor should you be charged retroactive interest as your payments come due again.
If you check your account and that doesn’t seem to be the case, contact your student loan servicer, an advocacy group or the federal Consumer Financial Protection Bureau.
Why is my loan balance larger than when I graduated even though I’ve made regular payments?
Because, for many with student debt, interest has been piling up for years. Nearly half of borrowers are on income-driven repayment plans that peg their monthly payment amount to their income in order to make repayment more manageable.
But the reduced monthly payments might be too little to cover the monthly interest on their loans.
The leftover unpaid interest is then added to their loan balance and accumulates interest, which can cause borrowers who are making regular payments to owe even more than their original debt.
A new, income-driven repayment plan introduced by the Biden administration last month, called the Saving on a Valuable Education plan, SAVE for short, addresses this by wiping out any monthly interest not covered by a borrower’s monthly payment.
For instance, if borrowers $30 monthly payments don’t cover all $50 of their monthly interest, the remaining $20 in unpaid interest would be erased. Previously, that $20 would pile up, accumulate interest and make loan balances grow even for borrowers making regular payments.
People with federal undergraduate and graduate subsidized and unsubsidized loans are eligible for the new program. Apply online at studentaid.gov.
Since President Joe Biden’s debt cancellation program was struck down by the U.S. Supreme Court this summer, the Biden administration has introduced alternative forms of relief through the U.S. Department of Education.
Evan Vucci / AP
STUDENT LOAN SERVICERS
What are loan servicers?
You might see names like Nelnet, Edfinancial or Mohela on your student loan bill. These are student loan servicers, private companies and organizations that bill and collect principal and interest from borrowers on behalf of the government. Borrowers owe money to the federal government, not to servicers.
How do they make money?
Servicers do not keep the interest collected on a loan as their payment. In the past, some got a small percentage of each loan they managed, Kantrowitz said. But today the federal government pays servicers a flat monthly fee per loan. That fee typically is highest for loans that are in repayment and decreases for delinquent accounts or borrowers in forbearance.
TAXES
If my student debt is canceled, do I have to pay federal taxes on it?
No — but only if your loan is canceled this year or in 2024 or 2025.
Brunson said legislation passed during the pandemic exempts most student loans canceled between 2021 and 2025 from federal taxation. Loans made by an employer to cover an employee’s tuition will still be taxed if they are erased.
Canceled student debt usually is taxed, he said. Unless Congress extends the provision, most borrowers granted loan cancellation after 2025 will have to count forgiven debt as income on their tax returns. That could trigger a big IOU to the IRS.
For example, if a borrower is in the 1% tax bracket, $50,000 of loan cancellation could mean a $5,000 tax bill, Brunson said. A borrower in the 22% tax bracket would owe $10,000.
“Over the course of a person’s life, it’s definitely a better deal, even if you … have to pay taxes on the amount,” he said. “But it is a onetime financial shock.”
Brunson said you can get on a payment plan with the IRS to spread your tax payments over an extended period, but you will have to pay interest.
What about state taxes?
Illinois borrowers won’t be charged state taxes on most student debt canceled between 2023 and 2025. That’s because Illinois defines taxable income the same way as the federal government.
But not all states operate this way. Brunson said Indiana opted to ignore the changes on the federal level. So Indiana residents should know this: If your student debt is canceled, expect a state tax bill.