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Canceling student loan debt – Lexington Law

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The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.

Lately, the federal government canceling student loan debt seems, for the first time, like it could actually happen. As of 2020, approximately 45 million Americans owe over $1.64 trillion in student loans. Looking at the graduating class of 2019, 69 percent of students with four-year degrees had to take out a student loan and were completing their education with an average student loan debt of $29,900.

Because of this and other troubling student debt statistics, the government canceling student loan debt (aka a debt jubilee) would help out many students, graduates and parents. 

What would it mean to cancel student loan debt?

There are already several existing programs that allow for student loan debt to be canceled or forgiven. Some of these programs are:

  • Public Service Loan Forgiveness
  • Teacher Loan Forgiveness
  • Perkins Loan Cancellation
  • Death Discharge
  • Bankruptcy Discharge
  • Unpaid Refund Discharge
  • Total and Permanent Disability Discharge
  • Closed School Discharge
  • False Certification of Student Eligibility Discharge
  • Unauthorized Signature/Payment Discharge

Many of these programs are difficult to qualify for or are reserved for rare circumstances. So, while these programs exist to help people in unfortunate situations, they don’t typically apply to the general population. 

That’s why a greater and more widespread student loan debt cancellation would be fairly exceptional. However, it would come with some tax implications. 

Typically, when borrowers have a debt forgiven, they have to follow the Cancellation of Debt (COD) federal income tax rule. This rule states that anytime a debt is forgiven, that amount must be claimed as income tax for the year the debt cancellation happens. However, there are some exceptions to the COD tax rule when it comes to student loans. COD is federal income-tax-free when:

  • The loan is forgiven because the borrower worked in a specific profession (public sector, teaching, etc.)
  • The exception is due to the student’s death or disability
  • The student enacts the Defense of Repayment against the school (possible partial COD federal income tax exceptions may apply)

Under Joe Biden’s student loan plan, the massive rollout of a student loan debt cancellation would be tax-free. Of course, there’s no guarantee the version that will be approved by Congress will, in fact, be tax-free. If borrowers are forced to pay Cancellation of Debt federal income tax when their student loan is forgiven, it can cause what many are calling a “tax nightmare.” 

Let’s say a borrower has $80,000 in student loan debt and $50,000 is forgiven. Under the COD, that $50,000 is added to their income tax for the year. How much they will ultimately pay in taxes will depend on which income tax bracket they fall in, as this $50,000 will be added to the income they’re already making in that year.

Assuming they’ll owe 30 percent in taxes on this $50,000 forgiveness, they can expect to see an income tax bill of $15,000 for their student loan forgiveness. Of course, this is still lower than paying back the $50,000 in full, but it’s a large sum that an average borrower might have difficulty paying back. 

Benefits of canceling student loan debt

Canceling student loan debt has widespread benefits for individual borrowers and the American economy as a whole. Most importantly, this forgiveness would benefit lower-income people and groups that have been systemically disadvantaged. 

Currently, less than 20 percent of white student loan borrowers have a debt-to-income ratio of more than 0.5. This means fewer than 20 percent of white borrowers make an annual income equal to half or less of their total student loan debt.

For African American borrowers, this number rises to 30 percent. As a result, more African American students leave college at a greater disadvantage than their white counterparts. Such a disparity is detrimental to the American economy, which benefits most when there’s a fair and fully versatile workforce. 

Additionally, canceling student loan debt will offset the unreasonable costs of education. The cost of university has been rising faster than the average household income. When students graduate with excessive student loan debt, they don’t have as much disposable income and struggle to buy homes, start businesses or pay back debts. This is a detriment to the economy overall. 

The downside

One downside that many people bring up is that privileged families that don’t have issues paying back their student loan debt and choose to take expensive degrees will benefit from this initiative as well. However, the vast majority of borrowers are working-class and lower-income, and these are the people who would most benefit from the cancelation of student loan debt.

What is Joe Biden’s student loan plan?

Joe Biden has a comprehensive student loan plan that will be quite exciting for many borrowers if Congress allows it through. Biden first mentioned a proposal to cancel up to $10,000 in federal student loans per borrower in March 2020. This was proposed to be included in the 2020 CARES Act but was not approved. However, there remains the hope that this will still be included in future stimulus packages. 

The proposed Biden Plan for Education Beyond High School looks to update the Income-Driven Repayment (IDR) plan currently offered for federal student loans. As of right now, borrowers who choose the income-driven plan must pay between 10 and 20 percent of their income toward their loans. Biden’s proposed plan looks to lower this to five percent of income for borrowers making over $25,000. For individuals who make less than $25,000, there would be no interest and no monthly required payments. 

Additionally, under Biden’s new plan, all borrowers automatically go under the IDR plan unless they opt out. Under the current plan, borrowers have a wide range of plans to choose from, with the default being equal monthly payments over 10 years. Additionally, under the new IDR plan, students would have their loans automatically forgiven after 20 years of payments with no income tax applied to the forgiven portion of their loan. 

The Biden Plan for Education Beyond High School also highlighted that there would be a cap for student loan debt forgiveness. This cap is set to $10,000 per year for five years, so the maximum an individual borrower could get is $50,000. These caps would apply to both undergraduate and graduate debt. 

Lastly, Biden’s plan looks to make student loan discharge in bankruptcy much easier (to date, it’s been very difficult) and provide free tuition for students whose families make less than $125,000 per year. 

Other ideas being considered

U.S. Senate Candidate for Georgia Dr. A. Wayne Johnson has a close history with student loans. Previously, Johnson ran the student loan program at the U.S. Department of Education. Now, Johnson is proposing counter-ideas to Biden’s plan. His suggestions include:

  • Suspending student loan payments (and accruing interest) until the end of 2021.
  • Canceling all student loan debt (private and federal) that’s currently in bankruptcy
  • Canceling up to $50,000 per student in student loan debt—students who don’t have a student loan would be awarded an income tax credit of $50,000 instead
  • Removing student loan details from credit reports

Similarly, U.S. Senator Elizabeth Warren wants to cancel $50,000 of student loan debt for every borrower whose family makes less than $125,000 annually. 

How likely is it that student loan debt will be canceled?

With the election of Joe Biden, there’s a strong possibility that some version of canceling student loan debt will pass. The ultimate question will be what form it takes.

Will students see partial forgiveness or a wipeout of all their loans, or will the forgiveness only apply to low-income borrowers? It will depend on what Biden wants and what Congress allows to pass. Since Congress controls federal spending, Biden will likely need Congress’s approval for any plan to happen, which has the potential to be problematic. 

Managing your student loans

Don’t wait for student loan forgiveness to happen to you, because it’s unclear what the future holds. For now, keep managing your student loans responsibly—make payments on time and in full, because otherwise, you can hurt your credit score. 

As you make progress on your student loans, keep an eye on the news. You can watch as a clearer picture forms and it becomes public knowledge what the American government will do about student loan debt. Hopefully, there will be some good news soon. 


Reviewed by Cynthia Thaxton, Lexington Law Firm Attorney. Written by Lexington Law.

Cynthia Thaxton has been with Lexington Law Firm since 2014. She attended The College of William and Mary in Williamsburg, Virginia where she graduated summa cum laude with a degree in International Relations and a minor in Arabic. Cynthia then attended law school at George Mason University School of Law, where she served as Senior Articles Editor of the George Mason Law Review and graduated cum laude. Cynthia is licensed to practice law in Utah, North Carolina and Virginia.

Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.

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Does Getting Joint Credit Cards Have an Impact on Both Spouses’ Credit?

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couples credit history

While marriage can help you improve your financial situation, it does not automatically mean that you and your spouse will share a credit report. Your credit records will remain separate, and any joint accounts or joint loans that you open will appear on both of your reports. While this can be advantageous, it’s critical to remember that joint account activity can effect both of your credit scores positively or negatively, just as separate accounts do.

Users Who Are Authorized

An authorized user is a user who has been added to an existing credit account and has been granted the authority to make purchases. Authorized users are typically issued a card bearing their name, and any purchases made by them will appear on your statement. The primary distinction between an authorized user and a shared account owner is that the account’s original owner is solely responsible for debt repayment. Authorized users, on the other hand, can always opt-out of their authorized status, although the principal joint account owner cannot.

If your credit score is better than your spouse’s as an authorized user, he or she may benefit from a credit score raise upon account addition. This is contingent upon your creditor notifying the credit bureaus of permitted user activity. If your lender does report authorized users, the activity on your account may have an effect on both you and your spouse. However, some lenders report only positive authorized user information, which means that late payment or poor usage may not have a negative effect on someone else’s credit. Consult your lender to determine how authorized users on your account are treated.

Joint Credit Cards Have an Impact on Your Credit Score

Opening a joint credit account or obtaining joint financing binds both of you legally to the debt’s repayment. This is critical to remember if you divorce or separate and your spouse refuses to make payments, even if previously agreed upon. It makes no difference who is “responsible,” the shared duty will result in both partners’ credit histories being badly impacted by late payments. Regardless of changes in relationship status or divorce order, the creditor considers both parties to be liable for the debt until the account is paid in full.

Accounts Individuals

Whether you’re happily married or divorced, you and your spouse may decide to open separate credit accounts. Most creditors will enable you to transfer an account that was previously joint to one of your names if both of you agree. However, if there is a debt on the account, your lender may refuse to remove your spouse’s name unless you can qualify for the same credit on your own. Depending on your financial status, qualifying for financing and credit on a single income may be tough.

Considerations

While creating the majority of your accounts jointly with your spouse may make it easier to obtain financing (two salaries are preferable to one), reestablishing credit independently following a divorce or separation is not always straightforward. To make matters worse, your spouse may wind up causing significant damage to your credit rating following the separation, either intentionally or through irresponsibility – making the financial situation much more difficult.

Before you rush in and open accounts with your spouse, take some time to discuss the shared responsibility of these accounts and what you and your husband would do in the event of a worst-case situation. These types of financial discussions can be difficult, especially when you rely on items lasting a long time, but a mutual understanding and respect for each other’s credit can go a long way toward keeping your score when sharing an account.

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Should you pay down debt or save for retirement?

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rebuilding credit

While establishing a comprehensive, workable budget is undeniably one of the most important factors in maintaining a healthy financial life, it can also be one of the most difficult. For those who are struggling with personal debt, building a budget can be particularly challenging. When the money coming in has to stretch like a contortionist to cover expenses, it can be hard to determine where to focus — and where to trim.

Sometimes, the battle of the budget can come down to a choice between dealing with the present — and thinking about the future. When your income is running out of stretch, do you pay off your existing debt, or do you start saving for retirement? At the end of the day, the solution to that particular dilemma depends on the type of debt you have and how far you are from retiring.

If you have high-interest debt, pay it down

When considering how to allocate your budget, it’s important to understand the different kinds of debt you may have. Consumer debt can be categorized into two basic types: low-interest debt and high-interest debt, each with its own impact on your credit (and your budget).

In general, low-interest debt consists of long-term or secured loans that carry a single-digit interest rate, such as a mortgage or auto loan. Though no debt is the only real form of good debt, low-interest debt can be useful to carry. For instance, purchasing a home with a low-interest mortgage can actually save you money on housing costs if you do your homework and buy a house well within your price range.

High-interest debt, on the other hand, typically has a hefty double-digit interest rate and shorter loan terms, such as that of a credit card or payday loan. High-interest debt is the most expensive kind of debt to carry from month to month and should always be priority number one when building a budget.

To illustrate why you should focus on high-interest debt above everything else, consider a credit card carrying the average 19% APR and a $10,000 balance. If the balance goes unpaid, that high-interest credit card debt will cost $1,900 a year in interest payments alone. Now, compare that to the stock market’s average annual return of 7%, and it becomes clear that you’ll see significantly more bang for your buck by putting any extra funds into your high-interest debt instead of an investment account.

If you are having trouble paying off your high-interest debt, there may be some steps you can take to make it more manageable. For example, transferring your credit card balances from high-interest cards to ones offering an introductory 0% APR can eliminate interest payments for 12 months or more. While many of the best balance transfer cards won’t charge you an annual fee, they may charge a balance transfer fee, so do your research. You’ll also want to make sure you have a plan to pay off the new card before your introductory period ends.

Most balance transfer offers will require you to have at least fair credit, so if your credit score needs some work, you may not qualify. In this case, refinancing your high-interest debt with a personal loan that has a lower interest rate may be your best bet. Make sure to compare all of the top bad credit loans to find the best interest rate and loan terms.

If you’re nearing retirement, start to save

The closer you get to retirement age, the more important it becomes to ensure you have adequate retirement savings — and the more pressure you may feel to invest every spare penny into your retirement fund. No matter your age, however, paying off your high-interest debt should always remain the priority, as it will always provide the best rate of return (as well as likely provide a credit score boost).

Indeed, no matter how tempting it becomes, you should avoid reallocating money you’ve dedicated to paying off high-interest debt to save for retirement. Instead, the focus should be on re-evaluating your budget to find any additional savings you can. To be successful, you will need to make a strong distinction between want and need — and, perhaps, make some tough lifestyle choices.

Though simply eliminating your daily coffee drink won’t magically provide a solid retirement fund, saving a few bucks by homebrewing while also eliminating a pricey cable bill in favor of an inexpensive streaming service — or, better yet, free library rentals — can add up to big savings over the course of the year. The ideal strategy will involve overhauling every aspect of your lifestyle, combining both large and small cuts to develop a lean budget structured around your long-term goals.

Of course, while you should never allocate debt money to your retirement savings, the reverse is also true. It is almost always a horrible idea to remove money from your retirement account before you hit retirement age — for any reason. Withdrawing early means you will be stuck paying hefty fees for withdrawing money early and, depending on the type of account, you may also have to pay significant taxes.

Aim for both goals by improving income

As you take the necessary steps to pay off debt and save for retirement, you may have already stretched the budget so thin it’s practically transparent. In this case, it is time to consider ways to improve your overall income. Increasing the amount you have coming in not only provides extra savings to put toward your retirement, but may also speed up your journey to becoming debt-free.

The easiest solution may be to look for ways to increase your income through your current job; think about taking on additional shifts or overtime hours to earn some extra cash. Depending on your position — and the time you’ve been with the company — consider asking for a pay raise or promotion, as well.

If you do not have options to make more money at your day job, it may be time to find a second job. Look for opportunities that provide flexible schedules that will accommodate your regular job; many work-from-home positions, for example, can easily fit into most work schedules. Doing neighborhood odd jobs, such as babysitting and dog walking, may also provide a solid income boost without interfering with your existing job.

For some, the need to pay off debt and improve retirement savings can be more than just a source of stress — but a hidden opportunity to begin a new career adventure. Instead of being weighed down by yet more work, use the desire to better your budget as a reason to explore the profit potential of a passion or hobby. Starting a small online store, part-time consulting service, or other small business can be a great way to improve your income and your overall happiness.

While it may sound intimidating, starting a side business can be as simple as putting together a professional looking website and doing a little marketing legwork to spread the word. And no, building a website isn’t as scary — or expensive — as it seems, either. A number of the top website builders now offer simple drag-and-drop interfaces perfect for putting together a professional-looking web page in minutes (without breaking the bank).

Learn how you can start repairing your credit here, and carry on the conversation on our social media platforms. Like and follow us on Facebook and leave us a tweet on Twitter.



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How does a loan default affect my credit?

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loan default

Nobody takes out a loan expecting to default on it. Despite their best intentions, people sometimes find themselves struggling to pay off their loans. These types of struggles happen for many reasons, including job loss, significant debt, or a medical or personal crisis.

Making late payments or having a loan fall into default can add pressure to other personal struggles. Before finding yourself in a desperate situation, understanding how a loan default can impact your credit is necessary to avoid negative consequences.

30 days late

Missing one payment can further lower your credit score. If you can pay the past due amount plus applicable late fees, you may be able to mitigate the damage to your credit, if you make all other payments as expected.

The trouble starts when you (1) miss a payment, (2) do not pay it at all, and (3) continue to miss subsequent payments. If those actions happen, the loan falls into default.

More than 30 days late

Payments that are more than 30 days past due can trigger increasingly serious consequences:

  • The loan default may appear on your credit reports. It will likely lower your credit score, which most creditors and lenders use to review credit applications.
  • You may receive phone calls and letters from creditors demanding payment.
  • If you still do not pay, the account could be sent to collections. The debt collector seeks payment from you, sometimes using aggressive measures.

Then, the collection account can remain on your credit report for up to seven years. This action can damage your creditworthiness for future loan or credit card applications. Also, it may be a deciding factor when obtaining basic necessities, such as utilities or a mobile phone.

Other ways a default can hurt you

Hurting your credit score is reason enough to avoid a loan default. Some of the other actions creditors can take to collect payment or claim collateral are also quite serious:

  • If you default on a car loan, the creditor can repossess your car.
  • If you default on a mortgage, you could be forced to foreclose on your home.
  • In some cases, you could be sued for payment and have a court judgment entered against you.
  • You could face bankruptcy.

Any of these additional consequences can plague your credit score for years and hinder your efforts to secure your financial future.

How to avoid a loan default

Your options to avoid a loan default depend upon the type of loan you have and the nature of your personal circumstances. For example:

  • For student loans, research deferment or forbearance options. Both options permit you to temporarily stop making payments or pay a lesser amount per month.
  • For a mortgage, ask the lender if a loan modification is available. Changing the loan from an adjustable rate to a fixed rate, or extend the life of the loan so your monthly payments are smaller.

Generally, you can avoid a loan default by exercising common sense: buy only what you need and can afford, keep a steady job that earns enough income to cover your expenses, and keep the rest of your debts low.

Clean up your credit

The hard reality is that defaulting on a loan is unpleasant. It can negatively affect your credit profile for years. Through patience and perseverance, you can repair the damage to your credit and improve your standing over time.

Consulting with a credit repair law firm can help you address these issues and get your credit back on track. At Lexington Law, we offer a free credit report summary and consultation. Call us today at 1-855-255-0139.

You can also carry on the conversation on our social media platforms. Like and follow us on Facebook and leave us a tweet on Twitter.



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