What is a Forgivable Loan? Definition and Examples
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Summary:
Forgivable loans are a type of loan where borrowers don’t have to pay back some or all of the balance owed, provided they meet certain conditions. Usually, these loans are related to the federal government, but they are also offered by state-run programs and private companies (usually as a recruiting tool). In most cases, forgivable loans come with strings attached. If you don’t fulfill certain requirements, you may have to repay the “forgivable” loan.
Many people aren’t aware of the number of forgivable loans available. Often, these programs involve specific professions or levels of income or are provided during times of trouble, such as weather-related disasters or the recent COVID-19 pandemic. The Coronavirus, Aid, Relief, and Economic Security (CARES) Act provided funding for many pandemic-related programs, forgivable loans among them.
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CARES Act loans as an introductory example of forgivable loans
Designers of forgivable-loan programs often intend them to benefit more than just the loan recipients. Forgivable loans related to the pandemic are a prime example. Thanks to these loans, many businesses were able to keep their workers employed despite having to close down or do less business. At the height of the pandemic, the government at all levels (and in most places) imposed various restrictions meant to combat the spread of COVID-19. In this environment, many businesses would have been hard-pressed to stay solvent without help. Forgivable loans authorized by the CARES Act allowed many of these businesses to continue paying employees under conditions that would otherwise have forced widespread layoffs.
Setting aside the programs related to COVID-19, let’s take a look at some other examples of forgivable loans, what it takes to qualify for them, and who benefits from them in addition to loan recipients.
What is a forgivable loan?
Occasionally, if you meet certain criteria, you may be eligible to have all or part of a loan “forgiven,” meaning you don’t have to repay it. Generally speaking, it’s not usual to have your entire loan forgiven, but there are occasions where that does happen. In such cases, it’s kind of like a grant with conditions.
Most loan forgiveness programs are backed by the federal government, such as through the U.S. Department of Education (E.D.) and the Small Business Administration (SBA). But there are also some state and local programs, as well as other opportunities for loan forgiveness through private companies.
If you are considering a forgivable loan, carefully research the requirements you must meet to have the loan forgiven. If you make even a small mistake, you may end up paying for the entirety of the loan.”
Student loan forgiveness is one of the biggest and most well-known government programs. The SBA has options, as well, for businesses going through a rough patch for a variety of reasons. There are also forgivable loans available for first-time homebuyers and other families seeking homeownership.
Who benefits from forgivable loans?
The most obvious beneficiaries of forgivable loans are those who receive them: former students in specific occupations, low-income families, and struggling businesses. But the trickle-down effect of benefits can be widespread.
Government workers, teachers, nurses, nonprofit employees
For example, certain U.S. or state government workers, teachers, nurses, or employees of nonprofit organizations might be eligible to have the balance of their student loans covered. The specifications for forgiveness can be strict, but it is an option in many circumstances.
Low-income families
Low-income families in need of homeowner assistance can also benefit from forgivable loans in the form of down payment assistance or funds for home repairs, for instance. In some cases, the total loan might be forgiven if borrowers agree to stay in the home for a specified period of time. In other cases, borrowers might seek a grant rather than a loan.
Employees of certain companies
Some companies also use forgivable loans, or loan-repayment plans practically equivalent to loan forgiveness, as employee incentives. These can take the form of a signing bonus or financing for higher education. Many large corporations, in addition to smaller organizations, will pay for or reimburse tuition costs. But, if you fail to receive sufficient grades or leave the company too soon, you’ll have to pay them back. You may also have to pay back a signing bonus if you don’t stay for a specified amount of time.
As already noted, of course, employees of certain companies also benefited indirectly from forgivable loans granted to their employers in response to the economic disruptions of the COVID-19 era. Advocates of the program providing these loans, the Paycheck Protection Program (PPP) authorized by the CARES Act, argue that many business owners wouldn’t have been able to survive the first year of the pandemic without this type of assistance. We will learn more about this program when discussing specific forgivable-loan programs below.
Community benefits
Supporters of loan forgiveness programs also emphasize the important benefits certain communities reap as a result of some of these programs. The effects can be witnessed locally, nationally, and across the world.
Moving workers into certain communities and occupations
Often, as a condition of loan forgiveness, students interested in education, health care, or other fields may agree to work in specific communities (often in lower-income areas) in order to be eligible.
Students who see loan forgiveness as a sufficient incentive may even seek out certain occupations that can, supporters argue, be very beneficial to the residents of areas where these students end up living and working. Some of these area residents may themselves be young students who profit from the enriched community resources as they pursue their educations.
Encouraging volunteer and nonprofit work
Similarly, people who volunteer for the Peace Corps or AmeriCorps help people both nationally and globally in exchange for loan forgiveness and other benefits.
As well, nonprofits involved in community service provided valuable relief during the pandemic. Such help as relief from day-to-day cooking comes to mind. Because loan forgiveness can motivate some to work for such nonprofits, programs providing such forgiveness indirectly benefit those who use these nonprofits’ services.
Requirements for forgiveness
Loan forgiveness isn’t to be taken lightly. Depending on the organization in charge of granting the forgiveness, eligibility requirements can vary a great deal. In many cases, it can take years to qualify for these programs, but the money qualifying borrowers save can be significant.
Public service loan forgiveness
The Public Service Loan Forgiveness (PSLF) program, offered by the U.S. Department of Education through its Federal Student Aid (FSA) office, will forgive a portion of your student loans if you meet specific requirements. Proponents hold that this program offers students a real incentive to enter particular fields of study and that their entry into many of these fields benefits the larger community.
To qualify for this loan program, you need to be employed by a U.S. federal, state, local, or tribal government, or by certain not-for-profit organizations. Federal service also includes U.S. military service. Notice that government contractors are not considered government employers. So, it is technically just “certain” government workers who qualify — namely, all of those who are directly employed by some level of government and fulfill the additional requirements noted in the next paragraph. Contractors, even those who earn all their income from government contracts (and might even work in government offices), do not qualify.
Additionally, you must be working full time for the agency or organization, have federal student loans, and make at least 120 qualifying payments. Qualifying payments must be made under specific income-driven repayment plans, so be sure to talk to your loan servicer about the right plan to stay eligible.
The importance of talking to your loan servicer and making sure you understand and meet all program requirements cannot be overemphasized. In 2021, CNBC reported that only 5% of applicants for public service loan forgiveness had been approved.
A second program for certain federal employees
In addition to the PSLF program, a federal employee deemed “highly qualified” may be eligible for an additional program that has the same effect as loan forgiveness. This program is called “student loan repayment” and has requirements that the PSLF program does not. You can learn more from the U.S. Office of Personnel Management’s FAQ on the program.
Federal student loan discharge programs
In addition to loan forgiveness for public service, two opportunities to have a federal student loan forgiven deserve mention.
Borrower defense loan discharge
If you took out a federal student loan to attend a school that misled applicants or violated the law, you may be eligible to have your loan discharged. Successful applicants can get loans forgiven that they couldn’t get forgiven otherwise, or that they could only get forgiven after making years of payment on an income-driven repayment plan.
Closed-school loan discharge
If a school you were attending using a federal student loan closed down before you completed all your courses or not long after you withdrew (120 or 180 days, depending on when the loan funds were disbursed), you may qualify to have your loan forgiven. If your situation meets all the eligibility requirements, this program could free you from your loan obligation sooner than many loan forgiveness programs.
Economic injury disaster loans (EIDL)
EIDL is not a new program, but it was expanded during the pandemic. The expansion included an increase in the loan limits for eligible borrowers determined to have experienced economic injury as a result of COVID-19.
While large loan amounts won’t be entirely forgivable, amounts up to $10,000, (sometimes $15,000) may be forgiven. You may receive this amount as an advance while waiting for your loan to be approved. And this amount can be forgivable even if you don’t get approved for the EIDL loan.
To qualify, you must be a business based in the U.S., in any of the states or in a U.S. territory, specifically suffering from a loss of working capital directly related to the COVID-19 pandemic. Business difficulties due to an economic downturn or other causes will not qualify you for this program. Eligible businesses must have fewer than 500 employees and fall into the categories of cooperatives, agricultural businesses, nonprofits, faith-based organizations, sole proprietorships, or independent contractors.
Homeowner forgivable loans
Most states offer programs for forgivable home loan assistance. These programs usually help pay for the down payment and closing costs, making homeownership more affordable for many families. Check with your state or local housing authority for details.
Qualifications can include minimum allowed credit scores, limits on income and purchase price of the house, and a requirement to stay in the house for a certain number of years (anywhere from five to 15). The loans often come with no interest rate or a very minimal APR — some states only charge 1%. And if you adhere to the particular requirements, the loan is forgiven after you’ve lived in the house for the prescribed number of years.
Paycheck protection program
The Paycheck Protection Program (PPP), backed by the SBA, was created in response to complications from COVID-19. Now discontinued, the PPP, authorized as part of the CARES Act, was designed to address the economic hardships brought on by the pandemic and all that went with it. We’ve already pointed out how some business owners and employees benefited from this COVID-era program.
The incentive for the PPP loans was to allow small businesses to retain their employees and keep their businesses afloat. Businesses could use the loans to cover payroll costs as well as rent, utilities, and other operating expenses. Additionally, independent contractors and other sole proprietors were eligible to apply for the program.
Though you can no longer apply for a PPP loan, you can still apply for loan forgiveness if you already have one. To have your PPP loan forgiven, you must apply with the necessary documentation showing that your company:
- maintained employment and compensation levels,
- used the loan only for payroll and eligible operating expenses, and
- spent at least 60% of the loan on employee wages.
Restaurant Revitalization Fund
Bars and restaurants were some of the hardest-hit businesses during the COVID-19 pandemic because most of their income depends on customers being able to come into the establishment to spend money. The public health response to COVID-19 ruled out most indoor dining in most areas. As ways to maintain sufficient business income, delivery and curbside pick-up didn’t cut it.
In response, the American Rescue Plan Act established the Restaurant Revitalization Fund (RRF). Its aim was to mitigate the impact on small businesses that specifically sold food and beverages. Aside from traditional bars and restaurants, breweries, wineries, food trucks, snack bars, bakeries, and other eligible businesses were included in the program.
The only requirements to apply were that a business be involved in the sale of food and beverages. Funds could be used for average monthly payroll costs, rent, mortgages, utilities, construction of outdoor facilities, personal protective equipment (PPE), and related expenses. Technically, these weren’t “forgivable loans.” They were treated as government grants, and the money ran out quickly. But, as with PPP loans, recipients were required to document the use of funds and periodically report this information. In theory, misuse of the funds could result in recipients having to pay them back.
What if I don’t qualify for a forgivable loan?
If you don’t qualify for forgiveness but you still need money, you are not without options. One option is a personal loan. SuperMoney’s search tools can help you find the lenders and loan offers that suit you best. Click here to start your personal-loan search.
Pros and cons of forgivable loans
Do I have to pay taxes on a forgivable loan?
In most cases you do have to pay taxes on a forgivable loan, but not always. It depends on the type of forgivable loan. According to the IRS, “if you have cancellation of debt income because your debt is canceled, forgiven, or discharged for less than the amount you must pay, the amount of the canceled debt is taxable and you must report the canceled debt on your tax return for the year the cancellation occurs.”
For example, forgivable loans that are used as a recruitment tool are also considered compensation and are fully taxable the year they are paid. However, in some cases, your loan forgiveness might not be considered income, and you may not have to pay taxes on it. Examples of loan forgiveness that are usually not considered taxable income include:
- forgiven public service loans,
- forgiven teacher loans, and
- law school loans forgiven through loan-repayment-assistance programs.
If in doubt, talk with an experienced accountant or tax lawyer about the tax implications of your forgivable loans.
What’s the difference between a forgivable loan and a grant?
While grants and forgivable loans are managed differently, sometimes they can amount to the same thing for all practical purposes. A grant is a sum of money you receive that you don’t have to pay back. Students in financial need often receive grants. A forgivable loan, usually, is one where you may not have to pay back some or all of the balance if you meet certain requirements. In some cases, these loans will be 100% forgiven, practically turning them into grants, although there may be tax implications.
Key takeaways
- Forgivable loans are a type of loan that allows borrowers to have the balance of their loan either partially or totally forgiven if they meet certain conditions.
- Forgivable loans can be obtained through federal government agencies such as the U.S. Department of Education and the Small Business Administration, as well as through state and local agencies and independent companies.
- There are forgivable loans for students, businesses affected by disasters, and low-income homebuyers.
- In most cases, you will need to fulfill strict requirements to achieve loan forgiveness.
- Oftentimes, it can take many years to be eligible for loan forgiveness.
- Forgivable loans can often be a reciprocal arrangement with many parties benefiting from the transaction. The same is true of programs that produce similar effects though they are not actually forgivable loans. Examples include loan-repayment programs and grants.
- If you think you may qualify for a loan forgiveness program, it’s worth the time to learn what they are and how they work.
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